We’re sure for some of you, your stomachs flipped when you saw the words “adjustable-rate mortgages.”
That’s because you remember what happened about 20 years ago when homeowners with ARMs found themselves with payments that they couldn’t afford. Maybe you were one of them.
Today’s ARMs Aren’t Like 2008
ARMs got a bad name after the financial crisis of 2008 and deservedly so. Back then, there were some risky loans with small starting payments that later shot way up. Others let people borrow without proving how much money they earned.
But today, there are new laws to protect both borrowers and lenders. The biggest change is the Ability-to-Repay Rule, which says that before a lender makes a home loan, it has to check real paperwork (like pay stubs, W-2 forms, and tax returns) to make sure you can afford it. The lender also has to look at what your payment could be after the reset, not just the low starting payment.
So, you don’t have to worry. Today’s ARMs aren’t the same as the ones we saw during the crash.
The ARM Option
Here’s how an ARM differs from a more traditional mortgage. With a regular fixed-rate mortgage, your rate stays the same for your whole loan. But with an ARM, your rate is locked for the first few years, then it can move up or down based on market conditions.
Some people don’t like that level of uncertainty – and that’s okay. But others are drawn to this option specifically because there’s usually a lower rate to start when you opt for an ARM. And in an affordability-strapped market, that’s going to gain popularity.
Bankrate recently found that, in September, rates for ARM products were over a full percentage point lower than a regular fixed-rate loan. Cape Cod 5 reported last week that the rate for their 30-year fixed rate loan was 6.75%.
And for some buyers, that’s enough to turn “not right now” into “let’s do this.” You can see it in the numbers. Data from the Mortgage Bankers Association (MBA) shows that, in October, roughly 1 in 10 people applying for a mortgage chose an ARM (see graph below):
If you think you may want to consider this yourself, here’s what you need to know about how it works.
The 5/1 ARM
An ARM is like a phone or cable plan that has an introductory deal for new customers. You start out at a lower price, and then it adjusts after a specified amount of time. A popular loan is the 5/1 ARM.
The “5” means your introductory rate is locked for the first five years, and the “1” means that the rate can change every year after that. The rate change is called the “reset.” And here’s the really important part.
When your rate resets, your mortgage payment could go up or down. The good news is that most ARMs have caps, which are limits on how much your rate can rise each year and over the life of the loan. But either way, you have to be ready.
The Upsides and Potential Downsides
To see if this type of loan may be right for you, here are some things to think about and discuss with your loan officer:
Before you decide, ask your lender to work up the numbers and walk you through the different potential scenarios that you could run into with an ARM. That way, you go in with your eyes open.
Be Ready for the Reset
And, if you do go with an adjustable-rate mortgage, just know that you’ll have choices when the reset time arrives. You could:
- Do nothing and keep your loan in place if the new payment still fits your budget.
- Refinance into a fixed-rate loan with a payment that never changes.
- Refinance into another ARM with a new lower rate locked for a specified timeframe.
- Sell your home.
- Talk to the loan servicer about assistance or modification.
Remember, a refinance is a brand-new loan that you’ll have to qualify for – even if it’s on a home you already own. So, keep tabs on your credit and debt levels and ask your loan officer how major financial moves like job changes and major purchases will affect your mortgage readiness. It’s important to keep your credit and finances in “mortgage shape.”
Bottom Line
The smart use of an adjustable-rate mortgage could be your key to homeownership or making that move you’ve been delaying.
Is an ARM a good option for you? You need to talk with a loan officer to find out. If you need a referral, we can send you the contact information for loan officers who our buyers have been pleased to work with.
We’re happy to help…
Mari, Hank, and Colleen
508-288-1994 or 781-264-5517
Nothing herein should be construed as investment advice. You should always conduct your own research and due diligence and obtain professional advice before making any investment decision.
