Although ARM Mortgages originated in the 80’s, many of us are more familiar with the subprime ARMs that preceded the housing crash of 2008. As such, the term itself might bring up some question marks.
Here’s why Corbin Olsen (one of our favorite local mortgage brokers) believes ARM Mortgages could actually make for a huge amount of savings that you may not be considering. According to him, they can be used as a tool to lower the initial mortgage payment during the first few years of owning your home, allowing more people to enter the market at a time when both interest rates and home values are high, and could result in more overall savings than a conventional mortgage.
What is an ARM mortgage, anyway?
ARM stands for Adjustable Rate Mortgage. With a typical 30-year fixed conventional mortgage, you are looking at a fixed rate over the life of the loan. With an ARM loan, you are typically able to lock in a lower initial interest rate (for five, seven, or ten years) with the agreement that your rate may adjust after your initial term and every six months after that. Lower interest rates mean a lower mortgage payment, which could save you thousands of dollars over the initial term of your loan. While adjustable rates after that initial term may feel scary, most ARMs today include a fixed margin of around 2.25% to 2.5%. That margin is added to the index which is how your interest rate is calculated. In plainer terms, this means fewer surprises during the adjustable period and more time to refinance if you want to.
Ok, so if these are like the loans that caused the housing crash in ‘08, what’s different about them that makes them a safer bet now?
Well first, those Alt-A and SubPrime ARM loans were only fixed for two to three years, meaning interest could jump before homeowners were able to refinance into a fixed rate loan. Additionally, many of them had a 2 or 3-year pre-payment penalty (upwards of 1% to 3% of the loan amount) which would cause people to avoid refinancing even though it might have been a wise decision for them. The last, and possibly most problematic aspect of the 2008 subprime ARM loans was the fact that the margin (meaning the percentage of the loan that was added to the index) was between 5% and 7% as opposed to the current 2.25% or 2.5% margin. This meant mortgage payments could increase drastically, leaving homeowners financially strapped. All this made for much different ARM Loans in 2008 than the ones that are currently backed by Fannie Mae and Freddie Mac.
While an ARM Mortgage is considered a higher-risk option, one thing to note is that these types of loans can work in the homeowner’s favor, oftentimes outperforming 30-year fixed loans, and saving homeowners money during the initial few years of the loan.
Do we think an ARM mortgage is the right decision for me?
“Get educated about the products that are available to you. Be sure you understand your options. And, ultimately, go with your gut,” says Corbin. “If choosing a higher risk loan is going to keep you up nights or cause you to go against your own comfort levels, it probably isn’t going to feel worth it.”
Who does it work well for?
“I have seen this type of loan work very well for people who plan to be in their home for less than ten years and want to keep their costs low. I have also seen it used as a great tool for the self-employed, or anyone in the building or career growth phase of their lives to reserve cash while anticipating future financial expansion.”
How do I decide?
“Do your research. It’s important to me never to pressure my clients into anything they either don’t understand or don’t feel comfortable with. I like to present the facts and all kinds of places to research so people can make an informed decision. I’m a huge fan of creative problem-solving, especially in cases where my clients feel they are coming up against a lot of obstacles. ARM Mortgages have just worked really well as a creative solution to high-interest rates and high home values for some of my clients.”
"Current ARM Mortgages are all backed by Fannie Mae and Freddie Mac. You can take a look at the SOFR 'Secured Overnight Financing Rate' historical chart. I would recommend looking at the past ten years. While no one can predict the future and unexpected changes do happen, this should give you a reasonable indicator of what you can expect. Since 2010 the SOFR has fluctuated between zero and 1.5%."
What’s the takeaway?
An ARM Loan can be a good solution to a recent spike in interest rates and home values that have made mortgage payments and the initial costs of buying a home less affordable for some. They are useful for those who can reasonably anticipate financial expansion or a windfall in the future or for those who plan to stay in their home for ten years or less. It’s important to understand the risks involved and be sure you can afford increases in your mortgage payments. Get a good lender who can explain the pros and cons, what you can reasonably qualify for, and if it’s the right fit for you and your long-term financial goals.
You can get in touch with Corbin and take a look at the best ARM mortgage rates today by reaching out at his website Movement Home Loans.
