There has been a recent uptick in mortgage rates, and property prices continue to rise, so more borrowers are considering adjustable-rate mortgages. As rising fixed-mortgage rates price some borrowers out of the market, this alternative mortgage product may offer a more affordable entry point into homeownership.
The Comeback of Adjustable-Rate Mortgages and Why Interest rates on ARMs are often lower than those on fixed-rate mortgages for an introductory period but then fluctuate periodically for the balance of the loan's term.
This percentage more than tripled by September, reaching nearly 9%. Fixed mortgage rates have recently risen beyond 6 percent, a level not seen since 2008. This increase is closely correlated with this trend. Lower initial rates on adjustable-rate mortgages (ARMs) have become more attractive when higher fixed rates have reduced borrower purchasing power.
We should expect ARM volume to stay strong for a while. According to CoreLogic, adjustable-rate mortgages (ARMs) made up about 45 percent of all mortgages that originated in the middle of 2005. (The teaser rates helped fuel the real estate bubble). They've only made up 18% and 8% of all originations since 2009.
Should you go with an ARM or not?
Although it would seem obvious to take on more risk in exchange for a reduced monthly mortgage payment, not all borrowers should consider adjustable-rate mortgages (ARMs). Consider these factors as you assess the benefits and drawbacks of an ARM:
You’re not buying your everlasting home. It may make sense for a borrower with plans for a shorter time frame in their new home of five to 10 years, where they would likely sell before their rate resets," adds Kan.
As far as you're concerned, the stakes are low enough. If you're dead set on getting into a house now with a lower initial payment, you should be ready to take the chance that your interest rate and monthly payments will increase. Pete Boomer, executive vice president of PNC Bank, says that borrowers may decide that the ARM's lower monthly payment compared to the fixed-rate option is worth the potential for a higher rate in the future.
During the introductory time, you can pay more than the minimum. The interest savings from a reduced-rate ARM loan can be maximized if the borrower makes extra principal payments throughout the introductory rate period. (Bankrate’s supplementary mortgage payment calculator will help you weigh different possibilities.)
Don’t Disregard the Risks
To protect borrowers from being unable to make their new, higher monthly payment, "most ARM loans are now underwritten based on the highest payment predicted on the loan," explains Kan. "income and work situation, home market conditions that affect their ability to refinance or sell (if necessary) after their fixed period expires and more."
The phrase "if necessary" highlights the major danger of ARMs, which is that their value might fluctuate according to market conditions. So what happens if you get laid off as your trial time is winding down? A drop in the housing market could scuttle your plans to sell the house. Nothing in life is certain, so if you require a predictable monthly payment — or can’t accept any level of risk — it’s preferable to go for a fixed-rate mortgage, despite the premium.
In terms of ARM processors, which one is the most common?
If you qualify for an ARM and plan to get one, you'll have a few options. The 5/1 ARM is the most frequent type of adjustable-rate mortgage. The interest rate, principal, and interest payments will remain unchanged for the first five years of this ARM. After that, the "1" kicks in, and your interest rate will change annually in response to fluctuations in the market. Not only are 5/1 ARMs common, but so are 5/6 ARMs. The interest rate on this loan resets every six months instead of annually, but you still get the introductory rate for five years.
Due to the stability of the payments throughout the first decade of the loan, the initial rate is typically lower than it would be for a shorter adjustable-rate loan. The annual (or periodic) rate increase allowed by most ARMs is capped, and the total rate increase allowed over the life of the loan is typically capped as well. Bankrate's ARM calculator will help determine if you can afford the most feasible monthly payment, given your lifetime limit.
