Borrowers: Have You Even Considered an ARM?
by Tim Manni
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?
