The Bright Side of ARMs, a guest Blog by Nick Ursetta
An adjustable rate mortgage, called an ARM for short, is a mortgage with an interest rate that is linked to an economic index. An index is a guide that lenders use to measure interest rate changes. Common indexes used by lenders include the activity of one, three, and five-year Treasury securities, but there are many others such as the 11th District Cost of Funds as well as the LIBOR index (London Inter-Bank Offering Rate). The concept of an arm is fairly simple; the interest rate and thus your payments are periodically adjusted up or down as the index changes. In simple terms, this means that your interest rate can go up or down in any given year and have a direct correlating result on your monthly mortgage payment. As of recently, adjustable rate mortgages are no longer as common place in the lending market as they once were. ARM’s were said to be a one of the culprits in the financial collapse back in 2008 and since this time, many lenders and consumers were led to believe that the Adjustable Rate Mortgage was a bad mortgage products.
What many people don’t realize is that there are plenty of reasons why an ARM is a great mortgage product.
Most of the benefits associated with an ARM stem from the low introductory rate. The chart below shows the difference in rates between a 30 year fixed rate loan, and a 10, 7, and 5 year ARM. (All ARMs are tied to the LIBOR Index).
A lower initial rate can help a borrower in many ways.
For example, if the borrower knew for a fact they were going to move within a five year time frame, it would make more sense for the borrower to go with an ARM product because they would have a cheaper monthly payment than going with a conventional 30 year fixed rate mortgage. Using the table above, the borrower would save $167.40 per month. Over the course of 5 years that becomes a total savings of $10,044.00.
An advantage to having a low initial interest rate is that, if you plan to be able to pay your house off at a rapid pace, within 5 – 10 years, an Adjustable Rate Mortgage would save you a ton of money in terms of the interest that you would normally pay on a conventional 30 year loan.
Last, by paying a lower interest rate, your monthly payments would be lower, which could allow you to qualify for a larger purchase price. If you foresee your income increasing steadily over the next few years, it might make sense to get into the home of your dreams today, and an adjustable rate mortgage could be just the tool. The graph below shows how much lower your monthly payments would be by utilizing and ARM product vs. a 30 year fixed rate product.
Risk With Adjustable Rate Mortgage
As with all loan products, there is a certain degree of risk that the borrower will undertake when purchasing an ARM product. One risk in particular is known as payment shock. There is a chance that the initial interest rate will adjust upward and the borrower may not be able to cover the additional payment. It is important to always consult with a mortgage professional when deciding which loan product is right for you.
A big thank you to Nick Ursetta for writing his guest blog.
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