February 12th, 2018
Adjustable Rate Mortgages: What You Need To Know
Adjustable rate mortgages, commonly referred to as ARMs, are a unique type of home mortgage loan where borrowers have a low, fixed interest rate for a certain number of years (5, 7, or 10), but thereafter have adjustable/variable rates for the remainder of the loan term. Most people assume the rate will only climb after those first years, but that’s a misconception. It’s also possible for the rate to go down.
How high can an ARM go? Are there limits?
Yes, there are limits (it’s not a scheme to take your house away from you!). ARMs are usually capped at 5% above your original rate. So in this scenario, if you have a 5/1 adjustable rate mortgage at 3%, after the first five years your rate couldn’t go any higher than 8% for the next 25 years.
When is an ARM a good option?
An adjustable rate mortgage is a good option if you plan on moving again in the not so distant future. Whether you’re in the military, your job moves you around a lot, or you’re helping out a relative, it can certainly be a smart move to get an ARM if you know the house you’re buying isn’t your forever home.
Who shouldn’t get an ARM?
Many lenders don’t recommend getting an ARM if you are a first time buyer or if you are unable to make a large down payment (because then your payment might get even higher).
Despite what you may have heard, rates are very low right now (historically low, in fact), so they really have nowhere to go but up. With an ARM, your low monthly payment could very well skyrocket after five years. Even if you could feasibly make the payment, you might not be able to do anything else with your money — like go out to eat, update your wardrobe, or take a vacation. Being unable to do these things is what your grandparents called "house poor" in the good old days, meaning you’ve got the nice house, but that’s it.
Let's Do Some Quick Math:
You take out a $300,000 adjustable rate mortgage. In the beginning your rate is 3%; therefore your monthly payment would be roughly $1,265. However, five years go by and your rate suddenly jumps to 8%. Your monthly payment at 8%
would be roughly $2,200, which is a $935 jump from your original payment.
Does your bank account have an extra $935 every month?
But this is a worst case scenario. It’s very possible your rates could stay about the same or even go down.
What kind of risk tolerance do you have?
Most people like the peace of mind that comes with a standard mortgage. They know how much they’re going to need each month for the remainder of the loan term, and that brings about a certain amount of pleasing predictability
to their lives. If you’re like this, and you think it possible you might worry about money every night with an ARM, then it’s not for you.
However, if you plan on moving one day in the next few years and you have some extra cash every month, then the possibility of a lower rate in the future might make an ARM a financially savvy move. You’re OK with not knowing because even at the max rate, you know you’d be fine.
Learn more about MLD Mortgage, The Money Store in Florham Park, NJ .