NOW MIGHT BE THE TIME FOR AN ADJUSTABLE-RATE MORTGAGE (ARM)
Disclaimer: Good Day, Readers. WealthBuildingPowers blog is a financial literacy/competency blog and does not provide specific investment recommendations.
IS AN ARM RIGHT FOR YOU?
Two main mortgage options are adjustable-rate mortgages (ARMs) and fixed-rate mortgages. An ARM is a home loan where the interest rate can fluctuate based on market rates. Typically, the interest rate on an ARM is based on an index such as the prime rate. The monthly mortgage payments can either increase or decrease depending on the interest rate adjustment. ARM loans are attractive to borrowers who plan to sell or refinance their homes before the interest rate adjusts or gamble that interest rates will go down.
THE IMPACT OF CLIMBING RATES
As the Federal Reserve has increased Fed Rates, Mortgage rates have more than doubled in the past two years. They are purchasing a home unaffordable for millions of Americans.
FIXED RATE INTEREST RATE INCREASE IMPACT ON MONTHLY PAYMENTS {09-16-2020 TO 03-10-2023}
| DATE | INTEREST RATE | MONTHLY PAYMENT |
| March 10, 2023 | 7.299% | $2,392.89 |
| September 16, 2020 | 2.948% | $1,464.94 |
CAN YOU AFFORD AN EXTRA $928.00 PER MONTH MORTGAGE PAYMENT?
BENEFITS OF SELECTING AN ARM
- Typically lower interest rates than fixed-rate mortgages
- An attractive option for borrowers looking to save money on their monthly mortgage payments in the short term.
- The interest rate on an ARM is locked for an initial period. Five, seven, and ten years are standard options.
- After the lock period, the interest rate on an ARM can typically only be adjusted once per year.
- Usually, have both yearly and lifetime adjustment caps.
- If interest rates fall, interest rates for ARMs will decrease independently. Borrowers with fixed-rate mortgages must refinance to get a lower interest rate.
- Flexibility: An option for borrowers who don’t plan on staying in their homes for a long time. If a borrower plans on moving before the interest rate adjusts, they can take advantage of the lower initial interest rate and avoid paying higher rates.
CONSIDERATIONS BEFORE LOCKING AN ARM
- Potential Higher Rates in the Future: While an ARM may start with a lower interest rate than a fixed-rate mortgage, there is the potential for the interest rate to go up. If interest rates rise significantly, this could lead to higher monthly payments and financial stress for the borrower.
- Uncertainty: Because the interest rate can change over time, borrowers may not know how much they will pay each month, making budgeting and planning difficult.
- Hard to Refinance: If borrowers decide to refinance their ARM to a fixed-rate mortgage, they may have difficulty finding a lender willing to take on the risk of an adjustable-rate mortgage.
CURRENT ARM RATES:
- 10/1 ARM: 6.18% today {Same rate for the first ten years, then can adjust each year up or down based on the benchmark rate.
- 7/1 ARM: 5.92% today {Same rate for the first seven years, then can adjust each year up or down based on the benchmark rate.
- 5/1 ARM: 5.81% {Same rate for the first five years, then can adjust each year up or down based on the benchmark rate.
CONCLUSION – WHAT TO KNOW BEFORE CHOOSING AN ARM
Locking in a fixed-rate mortgage is great when interest rates are low, such as in 2021. But if interest rates are high, like now, consider the pros and cons of an ARM.
READ AND UNDERSTAND ALL TERMS OF AN ARM
- How many years will the rate remain fixed?
- What is the maximum percentage the loan can increase in one year?
- What is the maximum percentage of loan caps?
Example Analysis: Loan $350,000; 10/1 ARM; Maximum Annual Increase 2%; Maximum Lifetime Increase 6%
| Loan Years | Max Interest Rate {Two percent annual increase. Lifetime is six percent cap} | Loan Payment |
| 1-10 | 6% | $2,098.98 |
| 11 | 8% | $2,567.17 |
| 12 | 10% | $2,988.41 |
| 13- Lifetime | 12% | $3,398.20 |
Best case in the above example, the loan payment stays at or below $2,098.98. Worse case, the loan eventually climbs to a maximum cost of $3,398.20. While I may be hoping to sell this property before interest rates increase or praying the rates eventually decline and I can refinance, I must be able to make the maximum payment in the worst case.
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ABOUT ME
I am a proud nerd (as my beautiful wife and daughter have told me) investment and finance blogger with an NC. State, Chemical Engineering, University Rutgers, MBA and Harvard University, Advanced Management education.
I left a corporate career because I desired to make a difference as a speaker and writer. I was blessed to be coached and mentored by strong women and men in my family and professional life. It is my time to serve and give back.
DISCLAIMER
I started my first business at ~13 years of age (a small but brilliantly created plant nursery). I am a successful investor in stocks, options, and real estate and am happy to share my finance and investment lessons. I am NOT a licensed financial advisor. Please do not construe my suggestions on this blog as recommendations for your situation. As an investor, you must establish your risk/loss tolerance. Investment in any asset involves risk, including complete loss.
Please seek your licensed CPA or fiduciary financial advisors for individual financial advice.
I write this weekly blog to make an impact by reaching an audience and demonstrating the need for financial literacy. I will help you get there.
