What Is An Adjustable Rate Mortgage (ARM)?
If you’ve been looking for a home loan or thinking about refinancing, then you’ve probably noticed the option of getting an adjustable-rate mortgage (ARM) instead of a fixed mortgage. An adjustable rate mortgage is a loan with an interest rate that is adjusted periodically based on the credit market.
The most popular type of adjustable rate mortgage is what we call a hybrid ARM loan. These ARM’s offer a fixed interest rate for the first 1, 5, 7, or even 10 years, then once that initial phase has expired, adjustments based upon the current market will occur.
Aren’t Fixed Rate Mortgages (the interest rate never changes) Always A Better Option No Matter What?
Not necessarily, some home buyers know that they’ll be relocating or paying the loan off within a few years. In fact, many home buyers will not end up staying in the same home for 30 years and would have saved by choosing an ARM vs fixed rate loan. ARM’s just aren’t as common because not everyone is comfortable with taking the risk.
What Are The Risks Of Going With An ARM?
If interest rates move higher after the initial five, seven, or ten year rate period, the mortgage payment would also increase. So if a person ends up living in the same home longer than the fixed rate period, they could experience the shock of a higher payment. On the flip side of that, if interest rates go lower, the monthly payments would also fall. However, The Federal Reserve keeps hinting that rates might be going up, or at least that rates won’t be going any lower in the near future.
What Are The Advantages Of An ARM?
Savings during the initial fixed-rate period on Hybrid ARMs can be substantial.
For example, consider a 5/1 ARM with an APR of 2.5% for the first five years, on a $165,000 mortgage vs. a fixed rate mortgage on $165,000 with an interest rate at 3.9%. Take a look at the tables below and see the difference in the total principal and interest paid after 1 year, and after 4 years.
| YEAR 1 | FIXED RATE | ARM |
|---|---|---|
| Initial Monthly Payment | $778.25 | $651.95 |
| Year 1 Total Interest Paid | $6,382.52 | $4,082.33 |
| Year 1 Total Principle Paid | $2,956.48 | $3,741.07 |
| Year 1 Total Payments | $9,339.00 | $7,823.40 |
| YEAR 4 | FIXED RATE | ARM |
|---|---|---|
| Initial Monthly Payment | $778.25 | $651.95 |
| Year 4 Total Interest Paid | $30,691.19 | $19,441.37 |
| Year 4 Total Principle Paid | $16,003.81 | $19,675.63 |
| Year 4 Total Payments | $46,695.00 | $39,117.00 |
WHY CONSIDER AN ADJUSTABLE RATE MORTGAGE?
If you are interested in an ARM, or Fixed Rate Mortgage, give us a call today, we’re happy to answer any questions, and help you get the very best financing for your specific situation!