IS AN ARM RIGHT FOR YOU?Is an ARM right for you? Is an adjustable rate mortgage loan a perfect answer to your mortgage loan requirements? ARMs were prevalent choice for years before mortgage loans became standardized with the creation of government-backed loans as well as loans approved using Fannie Mae or Freddie Mac standards when long term, fixed rate loans became the norm. ARMs are often the answer when interest rates overall are relatively high. During times of high rates, ARMs will be lower than fixed rate loans and can be an ideal opportunity under the right circumstances. Is an ARM right for you?
Lenders offer adjustable rate mortgages as part of their mortgage repertoire. An ARM has an index, a margin and caps and just as the name implies, can adjust over time but only based upon prescribed circumstances hard-wired into the original note. A common index for an ARM might be the one-year Treasury bill and a common margin 2.25 percent. If a borrowers’ ARM were set to adjust in 60 days, the lender would then take the Treasury index for that day then add the margin. If the index were 0.50% and the margin 2.25%, the new rate for the borrowers would be 0.50% + 2.25% = 2.75%. The new rate, until the next adjustment would be 2.75%.
ARMs can adjust based upon preset times. In the current market, most ARMs are of the “hybrid” type which means the rate is fixed for a predetermined period then turns into an annually adjusted ARM. Most ARMS after the initial fixed rate period can then adjust at either six month or one-year intervals. There are consumer protections on ARMs, called “caps” which limit the swings when rates adjust. A common cap might be 1.00% over the previous rate.
An ARM can be an excellent choice for those who do not anticipate owning the property for a long period of time. Why? Let’s say the current fixed rate for a 30 year mortgage is 4.25%. A 5/1 hybrid ARM could have an interest rate of 3.25% which is fixed for five years. By taking the ARM, the borrowers save each and every month for the next five years before the loan can adjust and even when it does adjust there are consumer caps that limit how high the first adjustment can be.
ARM hybrids come in 3/1, 5/1, 7/1 and 10/1 options. The longer the fixed term, the higher the rate will be. That said, should someone who plans on selling the property within seven years and the 7/1 hybrid is lower than a fixed rate, then it can make sense to choose the 7/1 hybrid and save. Remember though, plans can change and there’s the possibility that same homeowner decides not to sell the house in seven years but keep it. There is an inherent risk for every ARM but when risk is properly evaluated, an ARM just might be right for you.
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