Should You Consider an ARM?

Consider an Adjustable Rate Mortgage - ARM

Why Buyers Consider an ARM

Buyers may consider an ARM due to the current state of the market. Rising interest rates compounded with increasing home prices are causing affordability issues for many buyers. That is why more buyers are considering adjustable-rate mortgages.

Mortgage rates are near their highest point since 2009. “While housing affordability and inflationary pressures pose challenges for potential buyers, house price growth will continue but is expected to decelerate in the coming months.” said Sam Khater, Freddie Mac’s Chief Economist.

Fixed and Adjustable Rate Comparison

A $400,000 home with 10% down payment and a 30-year term can be financed at a 5.27% fixed-rate mortgage. Or, it can be financed at 3.96% for a 5/1 adjustable-rate mortgage. The principal and interest payment will be $1,992.40 for the fixed-rate loan. For the ARM, the payment will be $1,710.40. This saves the buyer $281.99 per month for five years.

There is an additional savings for the buyer choosing the adjustable-rate mortgage because the unpaid balance at the end of the five-year first period is $6,429 less than the fixed-rate. The total savings to the buyer on the adjustable-rate during the first period is $23,348 or $389.13 per month for sixty months.

How ARMs Adjust

At the end of the first period, the rate on the mortgage can adjust according to the current index plus the margin. This is subject to the caps as specified in the note. These safeguards remove control from the lender or servicer from arbitrarily raising the rate.

The caps restrict the payments from going up more than a certain amount at each period. It also may restrict increase overall, for the life of the mortgage. A common cap might that limit adjustments to 2% or less, up or down, at any given adjustment period. This can be further limited to no more than 6% above or below the initial note rate.

Adjustable-rate mortgages must adjust downward if the index indicates a reduction at the anniversary of the adjustment period. The overall trend has been lower rates for the past thirty years until recently.

Adjustable Rate Comparison Tool

Using an Adjustable Rate Comparison tool, you can project a breakeven point to determine at what point the ARM would be more expensive than the fixed-rate, assuming a worst case situation where the rates would increase the maximum at each period.

In the case of the previous example, the breakeven would occur at 7 years and 6 months. This means that if the buyer were to sell the home prior to that projection, the ARM would provide the cheapest cost of funds to purchase the home. On the other hand, if the buyer knew they would stay longer than that, it might be a safer option to go with the fixed-rate.

Analyze Your Options

Should you consider an ARM to purchase a home now? It is good to be aware of available options when financing a home. Analyzing, using the best information available, can help you make an informed decision. Make your own comparison using our ARM Comparison tool. Find current interest rates on Freddie Mac.