Many borrowers who purchased houses with ARMs during the subprime boom got hooked into using exploding ARMs; a 2% teaser rate could jump to 8% within two years, even if market interest rates didn’t change. These products are long gone.
Ebeling says, “Today’s ARMs are only a small part of the market, but here’s the surprise: Most don’t adjust for five or seven years,” and that can make sense to buyers looking for exceptionally low interest rates.
Home buyers might ask, “Given that 15-and 30-year fixed mortgage rates are at historic lows, why even consider an ARM?” Ebeling offers “if you pay off your mortgage in a short period you can save a bundle.”
That’s attractive when you plan to move in the next several years or if you want to pay off a big mortgage before you retire.
The biggest savings come if you pay off the loan within the five to seven years before the ARM adjusts, effectively turning it into a very short, very low-rate fixed mortgage.
Ebeling cites a Jumbo ARM example from the experts. “Say you plan to pay off a $750,000 mortgage within seven years. Get a jumbo ARM at 3.125% for the first seven years and you’ll pay $18,000 less interest than if you were to take a 15-year fixed-rate mortgage at 3.75% and pay it off over seven years.”
Learn the lingo – Typically, the most common ARMs are 5/1 or 7/1 ARMs and 2/2/6 or 5/2/5 caps with adjustments pegged to an index. The LIBOR index is among the most common of benchmark interest rate indexes. The 5/1 or 7/1 part means the rate is fixed for five or seven years then the rate will adjust up or down in one-year increments annually.
The 2/2/6 part means the maximum first-year adjustment is capped at two percentage points above the initial offered rate. After that reset the rate can adjust up or down up to two percentage points each year with a maximum lifetime adjustment cap of six percentage points.
Don’t go too short – If you anticipate selling your home in six years take a 7/1 ARM rather than a 5/1 ARM. The difference in monthly payment is minimal and you’ll have some wiggle room to sell your home before the rate resets.
Don’t go too big – ARM rates are lower than fixed-rate mortgages and can reduce your monthly payment. It may be tempting to purchase more house or to refinance for more than your existing principal to get extra cash. Just don’t stretch too much when taking an ARM. You’re still assuming interest rate risk, even if it’s put off for five or seven years.
