In the wake of the financial crisis, the Adjustable Rate Mortgage (ARM) got a bad reputation.
Of course, there was no lack of evidence in the case against ARMs. There were many negative characteristics associated with these loans, including balloon payments, rate and payment shock, prepayment penalties and negative amortization. And it would not be an overstatement to say that each of these negative aspects contributed to the mortgage meltdown and recession that followed.
Luckily, the politicians in Washington - in their infinite wisdom -pushed through a heap of financial regulations in response to the financial crisis. With the implementation of Dodd-Frank, balloon payments, prepayment penalties, no qualifiers and negative amortizing loans were outlawed, thus weakening the case against the ARM substantially.
Still, many borrowers are not aware the negative aspects of ARMs have been banned. Even so, why would you opt for an ARM when a much less risky and much easier to understand fixed-rate loan is available?
The short answer is money.
If saving tens of thousands of dollars over the course of seven years simply by making a lower monthly payment sounds like a good thing, an ARM could be for you. Before I get into the numbers, consider that most people who choose a fixed rate loan end up refinancing after less than seven years in favor of a loan with better terms.
Many adjustable rate mortgages have an initial seven-year period in which the rate is locked. In a situation in which the loan amount is $424,000, a 30-year loan would have a fixed rate of 3.625 and a payment of approximately $1,934 per month. With an ARM for the same amount, the rate would be around 2.875 and the monthly payment would be about $1,760.
As the seven-year period slowly ticks by, the homeowner with the ARM and the lower monthly payment would accumulate a savings of more than $14,600 that could be allocated toward the principal, or a new car, boat or TV.
In the case of a larger loan amount - $750,000, for example - the savings mount up considerably. An ARM with a seven-year lock in this situation would have a payment of about $3,112 and a 2.875 percent interest rate. A 30-year fixed, on the other hand, would have a monthly payment of $3,527 and a 3.875 percent interest rate. That amounts to almost $35,000 over seven years!
When you consider that most borrowers with fixed rate mortgages probably refinance sometime before the loan is seven years old - most likely spending a significant amount in closing costs and other fees - it becomes even easier to see why many people believe an ARM is a good option. The point is compounded by the fact that many ARMs are easier to qualify for versus a conventional 30-year fixed.
Of course, if you are speculating that interest rates will rise significantly over the next seven years or so, a standard 30-year fixed rate loan could be the best path for you to choose. Even if you think interest rates will stay the same or only increase by a small amount, yet your tolerance for risk is low, a 30-year fixed could be the best choice.
The safest, most effective strategy is to evaluate your financial situation and sift through all your options, utilizing every possible resource.
Give me a call at the number below and I will help you understand every option that is available to you, then help you decide on the best course of action to meet your needs and goals for the future.
Patrick Stoy (NMLS Numbers 39527 and 39166) has 18 years of mortgage lending experience. Patrick is CEO of Wilmington-based Market Consulting Mortgage, which he started in 2005 with a mission to build lifelong customer relationships by providing real value. To learn more about Marketing Consulting Mortgage, visit www.macmtg.com. Patrick can be reached at [email protected] or 910-509-7105.