Is an Adjustable Rate Mortgage (ARM) Right For You

Real Estate

I believe hard work helps one get ahead in this world, and one of the many luxuries that dedication to one's craft can create is the ability to own one's own home. As an experienced realtor with over twenty-one years servicing the Gulf Coast, I often tell people who are starting to get ahead to look into possibly getting an ARM as well. 

My bad pun aside, an ARM, or an adjustable rate mortgage if you don't feel like using realty slang, is one of the many options homeowners are faced with when securing a mortgage loan, although this option comes with (generally) lower qualifying interest rates and closing costs than you'd get with a fixed rate loan. In this blog post, I delve a bit into what makes the adjustable rate mortgage unique. 

Do you hate to gamble? Do you get anxious watching a slot machine spin? Are playing cards somewhat intimidating to you? Is sports gambling a completely unnecessary component to sports and believe that people should just be able to watch the game and enjoy it for what it is? Then an ARM probably isn't for you! See, with a fixed rate mortgage, the lender puts himself at far more risk than in an adjustable rate mortgage. To elaborate, in a fixed rate mortgage, regardless of how high or low the interest rates themselves go, the borrower's interest over the next 30 years will not change; it's as locked in as gold at Fort Knox. If you've ever wondered why fixed rate mortgages have such high interest rates, it's because whomever is supplying your home loan doesn't hate gambling, as even if they don't gamble at a casino or race track or with friends privately, the person or institution supplying your mortgage is risking their assets on not just the market itself, but your ability to repay them. With an adjustable rate mortgage, the risk is completely on you, the borrower. Depending on your ARM, your mortgage rate will change depending on a variety of factors every six months to seven years. I'll go into the various factors a bit later, but the most important thing to know is your rate can not change more than (typically, depending on your particular ARM) two percent from the previous year's rate. Most lenders would prefer to engage in a loan where the risk is more on someone besides themselves, so it is most certainly an easier task to get approved for an adjustable rate mortgage than it is for a fixed rate mortgage. 

You can borrow more usually this method, for certain. It doesn't matter what percent a lender requires the borrower's gross monthly income for the payment of principal, taxes, interest and insurance, the percent they allow for an ARM will be greater. It certainly is a trade off; the unknown facing a borrower during adjusting periods in exchange for lower initial qualifying rates and higher qualifying ratios. While 3/1, 5/1 and 7/1 adjustable rate mortgages exist, typically speaking, your interest rate is adjusted every six months to a year with most ARMs. This adjustment is based upon several factors, including the 11th District Cost of Funds and the general state of the economy. Remember though, interest rates will not change more than generally two percent in either direction per year. This protects not just you, but the lenders as well, creating a truly leveled playing field.

There's more than one type of mortgage, and in that same vein, there's multiple types of ARM's one can join into. One popular option is the LIBOR ARM, which really sounds like some science fiction book or movie, but in actuality can be as complicated as the plot of a convoluted time travel story. LIBOR stands for London Interbank Offering Rate, and the simplest explanation for what that is is that it's the rate that banks in Europe charge each other for overnight funds. LIBOR ARM's will almost certainly have the lowest interest rate available for any ARM options you have. To say a LIBOR ARM contract is pretty complicated is akin to saying Andre The Giant was a tall professional wrestler; be sure to thoroughly examine anything before you enter into it.

ARM's give borrower's a lot of options in exchange for some added risk, and one of those is a variety of payment options as wide as an old Cadillac. Just like a fixed rate mortgage, you can go the traditional monthly payments for thirty years course, but that's just the tip of the iceberg to ensure you don't end up sunk like the Titanic. For example, those with an ARM can make minimum payments, which just pays back the principal and neglects the interest. The interest from that payment is then added to the loan amount itself, increasing your debt but giving your pocketbook a temporary break. Then there are the interest only payments, which don't pay off your loan, just the interest for the month. These payments are incredibly low per month, but won't get you out of debt any faster. While an ARM leaves you with plenty of options, they each have their pros and cons.

To summarize, a LIBOR ARM is ideal for people who are looking for an incredibly low monthly payment or are trying to add equity with a refinancing. An ARM itself, with its significantly cheaper than fixed rate interest rates is for those who are expecting a lot of money in their future and those not planning on staying in that home for more than five years. Make sure your ARM's initial rates are indeed lower than what you can get with a fixed rate however, and be wary of ARM's where the closing cost will ruin any financial benefit to the low interest rates. I really only touched the surface of ARM's, as each individual loan is unique. Be sure to have your realtor look over any and all paperwork you don't fully understand.