Demand for adjustable rate mortgages all but disappeared from the home lending landscape after the 2008 financial crisis – until recently. With the Fed raising interest rates, including another hike last Wednesday, buyers are once again turning their attention to guns.
Conventional fixed-rate mortgages still lead, but ARMs gained strength in response to continued mortgage rate hikes in 2022 to the highest levels since 2008, reports Mortgage Bankers Association.
While the volume and public perception of guns has declined because of them contribution to the financial crisis of the 2000sthey are now more tightly regulated and provide an affordable path to home ownership for many.
Simply put, an ARM is a home loan with an interest rate that will change over time. ARM rates can go up or down, usually depending on the economy.
Hybrid ARMs are the most common. They have lower initial rates that are fixed for a period of time – usually three, five, seven or 10 years – before changing to a variable rate. A floating rate adjusts to changes in the rate index to which it is tied, such as the monthly average Treasury rate.
There are also two other types of ARM:
• Interest only weapons allow buyers to pay only the interest on the loan for a certain period of time before they have to start paying the principal.
• Weapon payment option allow buyers to choose how to make their monthly payment. Buyers can choose a combination of interest plus principal, interest only, or a low minimum payment that meets the basic loan requirements without necessarily reducing the balance.
ARMs can help some homebuyers combat rising interest rates by saving early in their term. This can lower down-payments when homebuyers are tight on cash, get homebuyers into the market earlier, or make buying a home cheaper in the short term than a fixed-rate mortgage.
To find out if an ARM might be right for you, here are some helpful questions to ask your lender:
What is a loan margin? Your lender can affect your rate by adding a few percentage points. This is called the margin, and it usually stays the same throughout the loan. A similar question to ask is what is the annual percentage rate (APR) of the loan.
What are the bid limits? While you should prepare for the possibility of higher monthly payments in the future, rate increases are not infinite. ARM has several types of rate limits:
• Recurring adjustment limits determine how much your rate can change between adjustment periods, including the initial adjustment after your fixed rate expires
• The lifetime limit increases over the life of the loan
• A payment limit limits the number of monthly payments that can increase with each adjustment.
Does the loan have a minimum interest rate? Some ARMs have a minimum rate called a floor ratethat the rate will not be adjusted lower.
Based on these answers, you will also need to ask yourself some questions:
Will I have enough money to cover the worst-case rate increase? Review your budget and bid limits. Calculate based on your current income. Any future revenue projections should be treated lightly until they are guaranteed. If you have or plan to take on additional debt, such as college tuition, make sure you can afford those expenses as well.
How Much Will an ARM Cost Compared to a Fixed Rate Mortgage? Request rates for both fixed rate mortgages and ARMs. Then compare monthly payments, down payment and other details to determine what’s right for you over the life of the loan.
An ARM is not a shortcut to buying a home you can’t afford. Just like with a fixed-rate mortgage, buyers need to review their financial and life plans to make sure they’re both ready to apply for and afford an ARM.
Your monthly payments will ultimately change whether you choose a fixed or adjustable rate mortgage because insurance premiums and property taxes can vary. Everyone’s plans and circumstances are different, but the bottom line is that your mortgage payments will stay the same for the life of the loan, whether you’re on a fixed or adjustable rate.
Damien Manno is Associate Vice President of Real Estate Lending at Ardent Credit Union.