Adjustable-rate mortgages, often referred to as ARMs, have made a comeback as homebuyers grapple with the highest conventional mortgage rates of this century. So, let’s break down what’s happening.
Just last month, CNN reported that the average introductory rate for a 5/1 ARM was nearly 1.5% lower than the average rate for a 30-year fixed-rate mortgage. Sounds enticing, right?
You might wonder why some folks are giving ARMs a second chance when, not too long ago, they had a pretty bad reputation. Back in the lead-up to the 2008 foreclosure crisis, some homebuyers took the plunge with teaser rates, only to see their monthly payments skyrocket when the rates reset. It was a financial rollercoaster, to say the least.
But here’s the twist: Congress has since stepped in and tightened the reins. They’ve put in place stricter regulations and improved transparency, making ARMs less risky than they used to be.
However, don’t let your guard down just yet. ARMs are still a bit of a gamble. The catch is that your interest rate doesn’t stay put for the entire life of the loan. It can go down, but it can also go up. It’s like a financial seesaw.
ARMs start with a fixed rate for a certain period, usually five, seven, or ten years. But after that, the interest rate may take a wild turn when it resets to whatever the current market rates happen to be.
For example, a 5/1 ARM gives you a fixed rate for five years, and then it gets reset every year afterwards. On the other hand, a 5/6 ARM keeps things steady for five years and then the rates fluctuate every six months. There’s a safety net, though—new regulations limit how much your ARM rate can leap up or down during these resets and over the life of your loan.
So, let’s put this into your money jar: Imagine buying a $400,000 home with a 20% down payment, planning to stay for seven years. With a 30-year fixed-rate loan at 7.57%, you’d shell out over $14,500 more during those seven years compared to a 5/1 ARM at 6.23%, even if rates decide to play hopscotch during the reset. ARMs often give you the chance to pay down more of the loan’s principal during those seven years. It’s like a financial one-two punch. The higher your mortgage rate, the more you dance with interest payments instead of tackling the principal.
But hold on! ARMs aren’t everyone’s cup of tea. Many folks still prefer the stability of a fixed-rate loan, even if it’s at 7% or more, because it means having predictable payments and the potential to refinance to a lower rate if the tides turn.
To make sense of all this in your situation, Freddie Mac has a calculator that helps you compare loans.