All Up in ARMS
Some first time homebuyers are paying more for their mortgage than they should be. That’s because most first-time home buyers move or refinance in the first 7 years of owning their home. But how can first time home buyers, or any buyer for that matter, pay less? It could be as simple as choosing a new loan type.
As rents have inched up nationwide, mortgage rates have dropped. According to Freddie Mac, 30-year conventional fixed rate mortgage rates are close to the lowest they’ve been in three years; and rates for FHA and VA mortgage rates have averaged even lower.
Most buyers don’t know that the 30-year fixed rate mortgage is not the only choice. There are some “less expensive” options to finance a new home. An adjustable-rate mortgage (ARM), for example, can be a more fitting choice for a first-time buyer or for a buyer who intends to move or do a home refinance within the next 10 years. ARMs offer lower mortgage rates than fixed-rate loans and, sometimes, the savings is substantial. Plus, the typical homeowner moves every 7 years. If you know you’re going to move, then, why pay extra for a 30-year loan?
What is an ARM?
An adjustable-rate mortgage (ARM) is a mortgage that has a set fixed rate period (either 3, 5, 7, or 10 years) and for which the interest rate adjusts annually after an initial fixed rate period.
ARM loans got a bad rap back in the early 2000’s and for good reason. But today’s adjustable-rate loans are carefully controlled. Here are some basic things to know about ARMs:
- For the first group of years, your mortgage rate is fixed and unchanged
- After the initial group of years, your mortgage rate adjusts once per year
- After 30 years, your loan is paid-in-full, as with any other 30-year loan
The adjustment process is regulated for loans via Fannie Mae and Freddie Mac (also known as conventional loans); and loans through the FHA and the VA (also known as government loans). Regulations now protect mortgage borrowers from having to accept huge jumps in their mortgage rate annually: rate changes are capped in their initial adjustment and lifetime caps are also in place.
For example, with a 5-year ARM, the initial mortgage rate of the loan remains fixed for a period of 5 years. After the 5 years are over, the mortgage rate changes on the loan’s “anniversary” every year for the next twenty-five years. The new rate is often figured based on the following formula.
(New Mortgage Rate) = (12-Month LIBOR Rate) + (2.75%)
This means that, after each adjustment, your new mortgage rate will be 2.75 percent plus whatever the 12-month LIBOR rate happens to be at that time. Of course, ARMs can adjust lower, too, and for the last decade, they have. Homeowners wise enough to take an ARM over a fixed-rate loan have beat the market pretty much every year since 2003.
An ARM is a good start
5-year ARM rates are lower than the 30 year fixed rate and have even been below three percent recently. This means that buyers can sometimes save hundreds of dollars a month by choosing an ARM over a 30 year fixed rate loan. If you know you’re going to move or refinance your home within the next 7 years, then, there’s little reason to pay more to get the 30-year fixed.
According to a recent report by the National Association of Realtors, millennial home buyers expect to live in their home for a period of 10 years. The report also notes that “expected tenure is generally longer than actual tenure“, which means that homeowners usually over-estimate the number of years they’ll spend in a house.
What Are Today’s ARM Mortgage Rates?
Home sales are rising and so are U.S. rents. Luckily, mortgage rates are low. If you’re considering a new home, it may be smart to consider your options — including ARM loans. Let us crunch the numbers fill out the form below for a no cost, no credit check, no obligation quote.