If you’re in the market to purchase a home or looking to refinance an existing residence, then you should consider whether or not an adjustable rate mortgage (ARM) is a better fit than a fixed rate mortgage. Contrary to public opinion, ARM loans have their place in the market and, at one point in time, made up nearly 30% of the overall origination volume. However, when the Great Recession hit and mortgage rates tanked, there was plenty of derogatory commentary cast that took aim at the ARM product.
Let me first say that an ARM loan doesn’t make sense for everyone. Individual goals, expectations, payment tolerance, stability, and a plethora of other items come into play. However, in the right situation, and with the proper setup and expectation, an ARM loan can make a lot of sense and save you a lot of money.
For example, let’s say you are purchasing your first home and are fairly confident you don’t plan on being in the property any longer than five years. The purchase price is $175,000 and with a 5% down payment, your loan amount would be $166,250 (conventional loan). To keep things really simple, I won't bore you with a few key assumptions. With that said, choosing a 5/1 ARM (caps will vary) would put you approximately $5,402 ahead of the game over a 60-month period as opposed to the fixed rate option. For someone just starting out, $5,000 is a lot of money. Frankly, it’s a lot of money for anyone, regardless of whether or not it’s their first home purchase.
Let’s look at another example: you are purchasing your second or third home, and it’s no more than a seven year investment. The purchase price is $350,000, and with a 10% down payment, your loan amount would be $315,000 (conventional loan). Choosing a 7/1 ARM (again, caps will vary) would put your equity position at the end of the 84-month term roughly $11,552 ahead as opposed to the fixed rate option. Again, a little over $11,000 over a seven year period is a lot of money, and if you were in this situation an ARM loan would make a lot of sense.
As fixed mortgage rates rise, ARM financing will become a more prominent fixture amongst residential mortgage lending. Why? Because it will allow you to purchase at the same price point you could have previously within a lower fixed rate environment. Meaning, if fixed rate options are the only product you are considering, and, as they rise, your purchasing power (assuming you have a max payment amount in mind) will continue to diminish. In order to keep the same purchasing power, an ARM product with a lower rate becomes a viable option.
Choosing the right mortgage product is an important decision, and in helping make this decision, it’s important to consult a qualified mortgage professional. They will ask the right questions, talk through difficult conversations, and explain the advantages and disadvantages of particular product scenarios.