Is an ARM (Adjustable Rate Mortgage) the right loan for you? Some think that interest rates aren’t low enough to justify refinancing. However, don’t miss the opportunity that an ARM may present. Moving to a 15 year fixed is popular because the interest savings can be big. With the lower interest rate comes a much higher payment. That lack of cash flow is what might lead someone to explore an ARM. When is it right for you? ARM criteria:
- You plan to live in your home for a limited time; less than ten, seven years or even less than five years. This is usually guided by life events. Maybe you bought a starter home and you know you’ll want to upsize. Maybe you are close to retirement and will want to downsize. Maybe you are just ready to move up to a bigger place. I’ve seen several people that want to move to be closer to their kids.
- Don’t take an adjustable rate loan to stretch the amount of your home purchase.
- Keep good cash reserves (6 months of house payments) in case you still live in the home when the rate adjusts.
What is the benefit of an ARM? A 5 year ARM is over 1% below a 30 year fixed rate, a 7/1 ARM is 3/4% less, and a 10/1 ARM is 3/8% less than a 30 year fixed. Let’s do the math. A 7 yr ARM with a .75% savings compared to a 30 year fixed means that after 7 years you are 5.25% ahead. That means that your rate could adjust up after 7 years, but you wouldn’t give back all of your savings for another 3-5 years. You are almost guaranteed to save money if you are in your home for less than 10 years. In a real world scenario we’ll use a $200,000 loan as an example. After 7 years you have saved $10,500 in interest. That’s a lot of money! What are the risks? First, don’t confuse the risk of an ARM with the risk of a Balloon. A balloon note is one where the entire balance is due after the introductory period is over. I’m not a fan of Balloon Notes. The next risk is that you don’t end up selling in the timeframe that you expect. You have the opportunity to refinance it at any time without a penalty. It also would be wise to keep some of the interest you saved liquid. That way if you payment does go up, you can access some of that cash for the increased payment. ARM Myths: ARMs got a lot of bad press during the economic downturn of 2008. This was caused by three things.
- Subprime ARMs – these loans adjusted after only two years, and their margin was very high so they almost always adjusted higher.
- Negative Amortization – Known as Neg Ams, these were loans where the interest rate adjusted every month, and worst of all the required payment didn’t even pay all of the interest. This meant that your balance was increasing every month.
- Interest Only ARMs. These were ARMs where the minimum payment just paid the interest and you didn’t make any progress against principle.
None of these three scenarios currently exist. An ARM is a financial tool that if used properly can save you thousands of dollars! More information: The best way to find out if an ARM, or Adjustable Rate Mortgage can save you money is to reach out to me and let me review your situation. Contact my team to setup a consultation by calling 314-200-LOAN (5626). Or, reach out to me directly by calling or texting me at 314-472-DOUG (3684).
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