Adjustable rate mortgages (ARMs)
Adjustable Rate mortgages have been around for more than 30 years in various forms, and are still among the choices offered to consumers. Mark Wells at Preferred Financial Services discusses the pros and cons of ARMs.
What are the advantages of an ARM compared to a fixed rate? The single advantage of an ARM is that the rate is lower than that of a fixed rate product, resulting in a lower payment.
How about the downside? The downside is the “adjustable,” which means that your rate can change at some point down the road, potentially increasing your payment.
Are there different kinds of ARM’s? ARM’s are available in 3-, 5-, 7-, and 10-year terms, meaning the initial rate can be fixed for 3, 5, 7, or 10 years. In addition to term differences, the caps on single-year rate adjustments and on lifetime rate adjustments can vary for the same ARM product.
How much can the rate change on my ARM? That depends on the product you select. Accompanying an ARM disclosure are the terms 5/2/5, or 6/2/6, etc. The first number is the maximum amount the rate can change the first time it changes, after the fixed rate time is up. The second is the maximum amount (up or down) the loan can adjust each period after the initial adjustment. The final number is the lifetime cap, the maximum amount the rate can adjust above the start rate, for the life of the loan.
When does the rate change? This depends on the type of ARM you select. A 5/1 ARM has a rate that is fixed for five years and then changes annually for the rest of the life of the loan. A 7/1 ARM has a rate that is fixed for seven years and then changes annually, etc.
How do I know if an ARM is the right product for me? A home represents not only the largest investment most people make, but is also the emotional center of the family, so my advice tends to be very conservative in taking on too much risk. An ARM can be an excellent product if you know you are going to move before the rate will change on your loan. It can also be a good product for the financially astute borrower who accumulates the savings generated by an ARM, and invests those savings wisely. It is very unwise to use an ARM to buy more house than you could afford with a fixed rate—you are setting yourself up for problems when your rate adjusts in the future. Bottom line: if you can afford the worst case payment, that is, the payment at the maximum rate your loan might go to, then you might consider an ARM and accept the risk of a higher payment in return for the savings you will generate. Otherwise, take the safer route of a fixed rate.
I welcome questions and comments, and would be happy to help anyone who would like to compare an ARM and fixed rate mortgage. I can be reached at 864-235-9596 or via email at Mark@TheGreatestRates.com.
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