Mortgage interest rates have risen three weeks in a row. If this trend continues, we will most likely see an increased demand for Adjustable-Rate Mortgage loans (ARMs). Last week’s post provided a brief introduction to ARM loans. You may think of ARM loans as one of the nasty products that helped lead to the collapse of the housing market. It’s true that there were some shady ARM products (like the NINJA loan – No Income No Job or Assets), but those were eliminated during the post-collapse clean up.
Modern-day ARM loans aren’t as risky as people tend to think when they are used in the right situation. This week’s post will compare an ARM and a fixed-rate loan.
The following variables will be used:
- $225,000 loan amount
- 20 percent down payment
- Assumption that the borrower wants to move in five years but instead sells in seven years
- ARM product is a standard 7/1 ARM
- Fixed product is a 30-year fixed rate
In this scenario the borrower ended up using the 7/1 ARM product which keeps the initial rate fixed for seven years. Despite the borrower planning on moving by the end of the fifth year, it is a wise decision to pad additional time in case things in the future don’t go as planned. The following chart reflects the difference:
In this case, the ARM product is a good choice. It saves the borrower $125 per month; $1,500 per year in exchange for a relatively low level of risk.
Where borrowers face slightly higher risk is when they stay in the home without refinancing beyond the initial seven-year fixed period. But even then, I say the risk is slight because the rates cannot skyrocket. Standard ARMs have interest rate caps set at 2 percent per year and 5 percent over the life of the loan. So, in this example, the highest the interest rate could ever get on the 7/1 ARM is 8.125 percent (5 percent above the starting 3.125 percent rate).
What if the borrower stayed another two years? If this happened the rate could increase 2 percent in the eighth and ninth year (although it’s not likely a rate would reach its cap each year). This next chart illustrates the payment totals though the ninth year:
As you can see, even after keeping the ARM loan for two years longer than the initial fixed period (four years longer than the borrower initially assumed), the total amounts paid are still in favor of the ARM by more than $6,000.
The purpose of this post is not to promote ARM loans but to help illustrate that they can be very useful in reducing total interest paid in many situations. If you don’t have any kids and are buying your first home, or if you are likely to get transferred by your company after a few years, an ARM loan may make sense. If you are married, have some kids, and are looking for a long-term place to call home, then an ARM loan may not be for you.
As a local business owner, I take great pride in helping my clients make the best financial decisions for their personal situations. My team at Fountain Mortgage takes all the necessary precautions to make sure our borrowers are well equipped with ARM solutions that protect them. Give us a call if you’d like to learn more.
This weekly Sponsored Column is written by Mike Miles of Fountain Mortgage. Located in Prairie Village, Fountain Mortgage is dedicated to educating, and thus empowering, clients to make the best financial decision possible for their situation. Contact Fountain today.
Mike Miles NMLS ID: 265927; Fountain Mortgage NMLS: 1138268