Is An Adjustable-Rate Mortgage Right For You?
There’s a perfect mortgage product for every mortgage borrower. And, for some, that perfect product is the adjustable-rate mortgage (ARM).
An ARM is a mortgage which offers introductory mortgage rates — known as “teaser rates” — for up to the first 10 years of a loan. After the teaser period ends, the loan’s mortgage rate adjusts annually to reflect current market conditions.
In exchange for accepting a mortgage rate that can change, banks offer low mortgage rates during the initial, non-adjusting period your loan.
The mortgage rate on a 5-year ARM, for example, will typically be close to 100 basis points (1.00%) less than the rate for a comparable 30-year fixed rate loan.
So, why might you choose an adjustable-rate mortgage over a fixed?
Well, if you’re a first-time home buyer and you don’t plan to make your home a “forever” one, choosing an ARM over a fixed-rate loan can yield huge cash savings.
Same for buyers who frequently move. There’s no sense paying for a 30-year rate if you’re going to move in six. Or, refinancing your home to a 30-year loan if you’re going to sell or refinance again soon anyway.
So, which is better — ARM or fixed? Read below and see what you think.
1. What’s The Current ARM/Fixed “Spread”?
When you’re shopping for a mortgage, the difference in mortgage rates between an adjustable-rate mortgage and a fixed-rate mortgage is known as the “spread”.
The spread is your incentive for using an adjustable-rate mortgage instead of a fixed. The bigger the spread, the more attractive the ARM will look.
For example, if you’re choosing between a 10-year adjustable-rate mortgage and a 30-year fixed, and the difference in mortgage rate is 12.5 basis points (0.125%), you may feel that there’s little reason to accept the risk of an adjustable-rate loan.
However, if the spread widened to 50 basis points (0.50%) or more, your mind may start to change.
In general, the shorter your adjustable-rate mortgage’s initial teaser period, the lower its starting mortgage rate. A 7-year adjustable will have a lower starting mortgage rate than a 10-year adjustable; and a 5-year adjustable will have the lower starting mortgage rate than a 7-year adjustable.
2. What’s Your Time Frame In The House?
Another factor which determines whether you should consider an ARM is the length of time you plan to live in your home; and, the number of years until you might conceivably attempt a home loan refinance.
According to the National Association of REALTORS®, homeowners typically own property for close to seven years before selling.
Older homeowners tend to own for a few years longer; younger and first-time home buyers tend to own for a few years less.
This statistic, which is based on decades of data, suggests that many U.S. home buyers would be better suited to an adjustable-rate mortgage than a fixed. This is because a large majority of homeowners sell their home before their hypothetical adjustable-rate mortgage would ever begin to adjust.
Therefore, if you don’t consider your next home to be your “forever home,” see what kind of money you might save with an adjustable-rate mortgage.
3. Is Your Mortgage A Jumbo Loan?
A jumbo loan, by definition, is a mortgage loan which exceeds the loan size limits for an area. Loan limits vary by region, ranging from $424,100 to $636,150.
If you want to borrow more than your area’s loan limit allow, there are mortgages still available to you. However, the fixed-rate pricing tends to deteriorate.
The difference in mortgage rate between a fixed rate loan within loan limits and one that’s outside of loan limits can be as high as 150 basis points (1.50%).
For ARMs, however, jumbo loans can get cheap.
It’s not uncommon to see jumbo ARM mortgage rates beat jumbo fixed-rate mortgage rates by 250 basis points (2.50%) or more. That’s a pretty big incentive to go with an adjustable-rate mortgage.