Home Buying by the Numbers

Financing (continued)

ADJUSTABLE RATE LOANS

What’s an ARM loan?

Some mortgage consultants get so used to dealing with mortgage terms that they simply forget to explain what each acronym stands for.  This can lead to great confusion on the part of the borrower.  ARM stands for Adjustable Rate Mortgage.  This is a type of mortgage, which starts out with a set interest rate for a predetermined number of years and then becomes adjustable according to whatever method the lender uses to determine interest rates.  Most lenders use the federal Prime rate, so whenever this rate goes up or down the lenders will adjust their interest rates up or down accordingly.  So if a mortgage loan consultant tries to talk you into what they call a 5/1 ARM then what they are trying to sell you is a mortgage which has a fixed rate for five years.  After the five years is up the interest rate has the potential to go up or down each and every year for the remainder of the loan, which is usually amortized over a thirty year period.  Other terms exist, but each one works in pretty much the same way: a 3/1 is fixed for three years; a 7/1 is fixed for seven years, and so on.  Generally, the lower the first number the lower the interest rate.

ARMS can be tricky.

Different lenders have different rules and regulations when it comes to their ARM loans.  Some lenders have caps on how high the interest rate can go, which means that they can tell you right off the bat what the very highest amount you will ever pay for your ARM might be.  Some lenders also have annual caps, such as never allowing an interest rate jump to go beyond one interest rate point each year.  Make sure that you understand the terms that your lender uses so that you aren’t surprised by a huge interest rate jump later in the life of the loan.

Lenders love financing ARMs.

Mortgage consultants are trained to make ARMs sound like the best idea for everyone because these sorts of loans guarantee lenders that the mortgage will follow current interest rate trends.  ARM loans are generally more profitable when they start out low and then the interest rates climbs higher.  This is great for the lender, but bad for the borrower.  For this reason you need to be aware that your mortgage consultant may glaze over fixed rate loans and keep steering you towards the idea of an adjustable rate mortgage.  Be prepared to fight for a fixed rate if that is what you want.  If you decide on an adjustable rate mortgage just make sure it’s because that’s what you have decided makes sense for your particular situation, and not because the mortgage consultant made it sound so cool.

When does an ARM make sense?

Many conservative financial advisors will caution people against taking an ARM loan under any circumstances because there is simply too great a risk that the monthly payments will go higher.  Other financial experts, however, may endorse an ARM loan under certain circumstances.  If a borrower knows exactly how long they will be in a new home they might tailor their ARM accordingly.  For example, a person who knows they will be in a home for four years might select a 5/1 ARM because in theory they will never see the interest rate fluctuate.  This sort of thinking can be flawed, however, since people never really know for sure what cards they will be dealt by fate.  What if they decide they love the house and want to stay forever? What if they have a hard time selling the house in a soft real estate market? There are no guarantees when it comes to homes, and people need to make their financial decisions based on this fact.