Adjustable Rate Mortgages or ARMs got a bad reputation during the mortgage melt-down of the not to distant past. Was the product itself at fault? No it wasn’t the fault of the adjustable rate mortgage itself, but the people that used them for the wrong reasons. Unscrupulous mortgage broker’s were using the teaser rate of option ARMS to attract uniformed consumers into a loan which was not in their best interest.
Adjustable rate mortgages are like any tool used in the correct way and it benefits the user. Use it improperly and it can lead to disaster. Let’s look at the correct and incorrect uses of adjustable rate mortgages. More importantly when adjustable rate mortgages should be used.
Adjustable rate mortgages should be used when their is a significant difference in the rate of a fixed rate mortgage and an adjustable rate mortgage. Whereas it makes economic sense and creates financial gain for the borrower with minimal possible consequences.
Furthermore, the time to use the adjustable rate mortgage is when the borrower is very certain of the length of time they expect to be in a home. For example, here in Houston, Texas we have a lot of transient borrowers due to the international business from the energy industry. Many borrowers know that they will only be here on an assignment for say five years and then will be transferred to another city.
In this case the client does not need a 30 or 15 year fixed-rate mortgage since they will be moving in five years. If a 5-1 adjustable rate mortgage where the interest-rate is fixed for the first five years and it is at least a half a point lower than the 30 year fixed rate. it makes sense both economically and financially to take the lower rate of the adjustable rate mortgage. Because, there is no long-term interest-rate risk as the client will not be in the home longer than the five year fixed part of the adjustable rate mortgage.
From the example above we can see the correct use of the adjustable rate mortgage is when you have certainty of the length of time you will be in your home and the interest-rate of the adjustable rate mortgage is at least a half a point lower than the 30 year fixed rate mortgage.
The times not to use an adjustable rate mortgage is when you are going to be in the home for more than seven years and/or the interest-rate of the adjustable rate mortgage is not lower by more than a half percent. In addition, I would never recommend an adjustable rate mortgage for the first-time home-buyer. The adjustable rate mortgage is just to complex for a first-time owner. Lastly, if you cannot afford the payments if the rate were to start adjusting you should always choose a fixed rate mortgage versus an adjustable rate mortgage.
In summary adjustable rate mortgages can be a very benefical mortgage product if used correctly.
