Adjustable Rate Mortgages (ARMs)

What are the advantages and disadvantages to Adjustable Rate Mortgages (ARMs)?

When borrowers see a property as a “short to medium” term investment, an adjustable rate mortgage product may be a sound option.

A 30 year fixed mortgage is the most popular mortgage in America. This is because it provides borrowers with the certainty of knowing that their mortgage payments (P&I) will stay the same for the duration of the loan. Borrowers often confuse the “fixed” element as a commitment that the entire mortgage payment will stay the same over the life of the loan. Since the taxes and insurance make up a portion of the escrow payment, and these charges will fluctuate over the life of the loan, ALL fixed rate mortgages are subject to some payment fluctuation. ARMs are just subject to base payment fluctuations (P&I) as well.

Instead of paying a premium (a higher interest rate) for a fixed rate mortgage, many borrowers are using ARMs to lower payments and pay less money over the loan term. An ARM will traditionally carry a lower rate than the equivalent fixed rate mortgage. In good markets, the ARM borrowers enjoy significant savings, but when markets worsen, the payments could also increase. ARMs are especially popular for borrowers that plan to move or refinance in less than 15 years. Why pay to secure a rate for a period longer than you plan to keep the loan?

There are also many inaccurate assumptions (myths) surrounding ARMs. Most of the horror stories originate from older loan products that were created before the current mortgage regulations. Today, few ARMs have the rapidly inflating payments that most fear. All new adjustable products have maximum monthly payment increases, maximum lifetime increases and most of all set adjustment intervals. This means that few ARMs today are structured to adjust more frequently than yearly or semi-annually. Borrowers won’t see their payments fluctuate from month to month. In actuality, borrowers with adjustable rate mortgages have historically paid less interest over the term of their loans.

Since few American homeowners keep mortgage longer than 10 years, ARMs have grown in popularity. Now there are newer adjustable products that many reference as, “Temporarily Fixed Mortgages (TFMs)”. They provide the lower rates of ARMs and the payment security of a “fixed” rate mortgage for a set number of years, and are then adjustable for the remaining term. For example, a borrower can get a 3-Year Fixed, 5-Year Fixed or 7-Year Fixed FHA mortgage, pay the lower payment and pay based on the market conditions after the fixed period. Since FHA and VA loans have no pre-payment penalties, in the event that markets severely worsened, they could always use a streamline refinance to convert into a fixed product.