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February 16th, 2010 (Modified on March 22nd, 2010)

Borrowers: Have You Even Considered an ARM?

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There are at least a couple reasons why you don’t hear much about adjustable rate mortgages (ARMs) anymore. Mainly it’s because the housing crisis has scared many borrowers away from any home-loan product without a fixed rate. Adjustable-rate products have gotten a bad wrap as they have been associated with other riskier characteristics like subprime credit or pay-option loans. While it’s true that hundreds of thousands of borrowers — who couldn’t properly afford an ARM in the first place — entered into default because their monthly payments increased when the rate on their ARM reset higher, we have fervently defended that ARMs are certainly not ‘evil’ or ‘toxic,’ if applied correctly.

Another reason why ARMs have been put on the back burner of borrowers’ minds is because the recent initiatives by the federal government aimed at lowering mortgage rates have been designed for conforming, fixed-rate products. “While ARMs aren’t very popular at the moment, they can still be used to a homebuyer’s advantage,” according to the latest issue of HSH.com’s Market Trends Newsletter. Here’s why:

A borrower buying a $375,000 home with a 20% downpayment would have a $300,000 mortgage. At recent rates, and compared against a traditional 30-year FRM, a 5/1 ARM would produce a savings of about $138 per month and would see a borrower spend over $11,000 less in interest over the 60-month fixed-rate period.

At the end of that period, the remaining balance of the loan would have shrunk by $3,000 more than the 30-year FRMs (that is, the borrower would have $3,000 more equity). This could be improved to a more significant degree by using the differential in payment ($138) as a prepayment for the ARM, which would produce another $9,000 in equity over that fixed-rate period.

Of course, selecting an ARM isn’t without risk; rates could rise in the future, eroding some of the accumulated savings. However, if a borrower banked the $138 per month for the entire period, they would have built an $8200 “mortgage subsidy account” to be used to ameliorate the effects of a rise in monthly payment after the 60th month. In the prepayment arrangement, they would have a $12,000 smaller loan balance, which would serve to partially offset the rise in monthly payment caused by a higher loan reset rate.

It’s true — ARMs have lost some of their popularity, but they haven’t lost their ability to save the right borrower a lot of money each month.

We want to hear from borrowers — have you even considered an adjustable rate mortgage? Why or why not?

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4 Responses to “Borrowers: Have You Even Considered an ARM?”

  1. RickG Says: February 16th, 2010 at 8:52 pm

    Nothing wrong with a vanilla ARM. We have done OK with ours – 80% LTV, 5/1 ARM, Caps: 2% annual, 5% lifetime; initial interest rate of 4% in late 2003. Fixed rates were 6% at the time. Adjusted to 5.25% in ‘08. That was my biggest concern year since the first adjusting year could have gone all the way to the lifetime cap. The sad state of the economy and the resulting low interest rates resulted in a rate drop to 3.625 in the ‘09 adjustment. That’s double good news. I save now, and I know that the next move can’t go above 5.625%. The lower rates have meant higher rate of amortization, so the mortgage balance is lower than it would have been with the higher fixed rate loan. The ARM really made sense when there was such big delta between ARM & fixed. I’m not sure that current ARM rates would entice me.

    It takes a disciplined person to bank the ARM savings – or to use them to prepay principal. I didn’t have it, but still believe the ARM has been of benefit to us.

  2. daviddecarlo (daviddecarlo) Says: February 16th, 2010 at 9:17 pm
  3. Tim Manni Says: February 17th, 2010 at 10:54 am

    Rick G,

    Thanks so much for commenting. Your scenario is exactly why ARMs can be a great fit for the right borrower. Even though you didn’t bank the savings, sounds like you’re still making out all right.

    Best of luck and thanks for adding to this article,
    Tim

  4. Business Loans can accelerate your business growth | Bad Credit Business Loans Consolidate Says: February 18th, 2010 at 3:33 am

    [...] Borrowers: Have You Even Considered an ARM? | HSH Financial News Blog [...]

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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