Adjustable-rate mortgages are back.
“Buyers are addicted to the lower interest rates. You can get between a half and a full point for a five- to seven-year ARM,” said John Adams, area manager of loanDepot Jacksonville’s offices.
Many homebuyers consider the 15- to 30-year conventional loan as the safest. The monthly payment stays the same throughout the life of the loan, although taxes and insurance costs can increase.
ARMs fell out of favor after the housing bust in 2008. Back then, underfinanced buyers were approved for three-year ARMS, and found after three years they could no longer afford their home.
Three-year ARMs are a thing of the past, Adams said.
The ARM allows for a set rate for five to 10 years. After that, the interest rate can increase substantially and continue to do so for the life of the loan.
The fixed-rate loan is more conservative, but it does have drawbacks. Because the rate is higher, the amount of house a buyer can afford diminishes.
As has been the case for a decade or more, those in a fixed mortgage may have watched as what they thought was a good rate at closing years ago was not looking so good as interest rates fell until this year.
To take advantage of a lower rate, those in fixed mortgages have to refinance their loan, which can be costly.
Failure to refinance at some point makes the home more expensive.
For example, consider a buyer with a 30-year fixed mortgage at 3% on a $300,000 house. Minus taxes and insurance, the monthly payment would be $1,265.
If that same buyer opted for a 5/1 ARM (the introductory rate remains the same for the first five years) at a 2.85% introductory rate that mortgage would be $1,240 for the first 60 months. That amounts to a total savings of $1,500 during the introductory rate.
But at month 61, that rate could jump drastically. In this example, the homeowner could be looking at a rate of 10.85% to 12.85%. And that rate could rise once or twice a year depending on the contract.
So with a savings of $1,500 over the course of the five-year introductory rate period, why consider an ARM?
Those savings rise when the buyer purchases a more expensive home. Adams said the ARM is for the buyer who has an exit strategy.
“If you know you are moving in a few years, there is no harm in looking at an ARM,” he said.
Military personnel would be candidates, as would executives who are transferred every few years.
Other candidates would be a buyer who knows that by the end of the introductory rate, cash will be in hand to pay off the remainder of the loan.
Buyers should shop for an ARM because interest rates and terms vary.
With cash transactions making up more than 30% of area sales, an ARM has another advantage, Adams said.
He has seen buyers borrow the cash needed for the house from a 401(k), pay cash for the house and then take out an ARM loan to pay back the 401(k) before incurring a withdrawal fee.
Again, this plan works if the buyer knows the cash will be available to pay off the remainder of the loan.
The same plan could be used for a 30-year fixed, but the interest rate will be higher.
Adams advises buyers, especially first-time buyers, to have the exact terms of an ARM explained to them step by step.
