An Adjustable Rate Mortgage, usually referred to as an ARM, is a type of mortgage product that typically is fixed at a rate below market rate for a specific number of years depending on the product selected and then after that fixed period becomes adjustable at a set frequency after that fixed period (for example annually or bi-annually).
Since this concept may be confusing, let’s break it down with an example:
Say you buy a home at $350,000. With a 20% down payment,* that leaves the remaining loan amount at $280,000 for a single family home.
Let’s also assume in this example, the homebuyer has an A+ credit score as of the application date.
- Using average interest rates at the time of this blog post, the 30-year fixed rate mortgage rate for this loan would have a rate of 7% APR, which results in a monthly principal and interest payment of $1,863.*
Or, you could get an ARM, at a rate under market rate – let’s say 5.5% APR.*
- 7/1 ARM (Seven years fixed rate, one year adjusted) with an interest rate of 5.5% APR, which would result in a monthly payment of $1,590 principal and interest monthly for the first 7 years.*
That is a monthly savings of $273! If we calculate the savings over that first 7 years of fixed rate, the ARM loan would save you $22,932 during the initial fixed period. I think you can agree, saving that much in your first years of home ownership can make a huge difference in long-term affordability.
Is this a trick?
Absolutely not. Lenders are willing to go below market rates because you are taking on some of their risk.
Isn’t it risky to leave to chance what the rates could be after the initial fixed rate period?
Even the best market analysts do not have a crystal ball. We aren’t able to say with certainty what will happen with rising and falling rates, but there are pros and cons to be considered with your lender’s advisement in every choice:
- If in 7 years, market rates are lower, then you can discuss your refinancing options with a lender who can help advise you on how to restructure your loan to either keep your monthly expenses affordable, or maybe even save you some money.
- But what if in 7 years the rates in the market are the same or higher? With an ARM loan from Service Credit Union, you will have a rate cap each time the loan adjusts and a lifetime cap for the whole loan. There are factors to consider here, so this is best discussed directly with your loan officer, who can speak to your particular loan parameters.
Wait, you said I could refinance?
The most common misconception is that you will be “stuck” in this loan structure when it’s no longer a good fit. In fact, most mortgages do not go to term, meaning, people work with their lenders to customize their lending product to their goals. Refinancing when rates drop is a popular example of this restructuring, but you may choose to refinance to get cash out and fix up the home if you are eligible. Or, the time may be right for you sell and get a different home, so you might not have the loan long enough to hit the adjustable period. Service Credit Union has ARMs with fixed periods up to 15 years with a below market rate, and there are no prepayment fees or penalties when you refinance a Service Credit Union mortgage. Eligibility for refinancing is dependent on a few factors including borrowers DTI, available equity in the home and the available rates at the time. Additionally, the amount of closing costs associated with refinancing may average between 3-5% of the loan amount.
While the ARM is a great product to recommend as a loan officer, as a member I was able to make my own homebuying dreams come true with a 5/1 ARM in 2019! Owning my own home in my early 20s wasn’t something I thought I could accomplish. The ARM loan was right for me, and now that I have become a Real Estate Loan Specialist, I often recommend the ARM to the members I work with. After my own experience, plus the opportunity to help many members make their own homebuying dreams come true, I want everyone to know that Adjustable Rate Mortgages are not scary; as a matter-of-fact, they could help you make your dreams come true, too.
Real Estate Loan Spec II
*Rate advertised is for example purposes only and not indicative of Service Credit Union’s rates at this time. Please see rates for available rates. Rates shown are Annual Percentage Rates (APR). Payment example assumes a loan amount of $280,000 for a single-family, owner-occupied purchase transaction with a down payment of 20% and a credit score of 740 or higher. Payment examples do not include taxes or insurance premiums. Payment obligation will be higher. A 30-year fixed term at 7.00% APR would result in 359 payments of $1,862.85 followed by one (1) final payment of $1,859.06. A 7/1 ARM at 5.50% APR would result in 359 payments of $1,589.81 and one (1) final payment of $1,589.39 assuming there are no rate adjustments applied after the initial fixed rate period of 7 years and the rate remains constant for the duration of the loan. ARM rates can adjust annually after the initial fixed rate period based on a margin of 2.75% added to the current T-bill index. The rate can rise or fall up to 5% in the first adjustment year and up to 2% in each subsequent adjustment period but will never adjust up or down more than 5% total from the original fixed rate. Floor rate of 2.75% APR applies. Subject to credit worthiness and dwelling requirements. Must be an existing member or eligible for membership.