An Adjustable Rate Mortgage (ARM) loan can be very useful for some homeowners. It has gotten a bad reputation over the past several years as people saw declining home prices and were stuck in loans that had expiring interest rates and no way to refinance them. The HARP loan program was created, in part, to help underwater homeowners refinance out of ARM loans and into fixed rate mortgages. Fixed rate mortgages are excellent for homeowners that plan on staying in their property long term.
When Should You Use an ARM Loan?
An ARM is for homeowners that expect changes in their life and do not anticipate keeping the same mortgage loan for over five to seven years. Studies have shown that most people move around every seven years. If you are one of those people having a fixed rate mortgage is nice for the “what if” but not designed for how you actually live your life.
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If you are…
• Moving within the next five years
• Completing a major remodel
• Paying temporary extra expenses like private school, college tuition, or daycare
• Starting a new business or a new job
You should consider the benefits of an adjustable rate mortgage. Since your current needs will be different from your long term financial or housing needs an ARM is a viable option for saving money. They have lower interest rates that fixed rate mortgages which means you can lower your monthly payment.
How Does an ARM Loan Work
When you refinance or purchase a home using an ARM your interest rate is set for a period of time. This is typically 3,5, or 7 years with an average term being five years. Even though your interest rate is secure for that time frame your loan payments are calculated based on a 30 year term (as if you will be paying on the loan for 30 years). Since the interest rates are lower,you can save hundreds of dollars on a monthly basis.
When the fixed time frame expires your interest rate becomes variable. At that time,you can either refinance, sell your home, or live with a variable rate. In recent years having a variable rate actually dropped the interest rate for many homeowners. This rate is completely based on the financial markets,so you take the risk of benefiting from it or being hurt by it in the form of higher interest rates when your fixed term expires. When you get your mortgage loan,you are assigned a margin over the index. Your margin stays the same while the index can fluctuate. Adding the two together equals your interest rate once it goes variable.
Speak With a Mortgage Banker
An ARM loan is more complicated than a fixed rate mortgage because it will eventually go to a variable interest rate. It is best to speak with an experienced mortgage lender that can evaluate your current and future financial needs than give you advice on the type of loan that can help you to accomplish your goals.
