Is an Adjustable-Rate Mortgage the Right Choice?
Reduce House Payments with the Best Mortgage Deal
Jul 13, 2009
Adjustable-rate mortgages (ARM) have declined in popularity in recent years. This is largely due to the popularity of fixed-rate mortgage products and the certainty that a consistent house payment provides homeowners. According to a report in May 2009 by the Mortgage Bankers Association (MBA), ARMs now account for just 2.3% of all current loan applications. This compares to a high of just over 30% in the mid-'90s. However, with the Federal Reserve setting interest rates so low, signing-up to an ARM may currently represent the best the mortgage deal.
Understanding the Adjustable-Rate Mortgage Index
Whilst a 30-year fixed-rate mortgage is set for the duration of the loan, this isn't the case for an ARM. The adjustable-rate mortgage index is the benchmark rate of interest that an ARM is tied to. Once the 1, 3, 5 or 7 year term elapses, a margin is added to the underlying index. For example, if an ARM is set at 5% and the margin is 2.5%, at the end of the term, the new interest rate charged will be 7.5%. The margin will be affected by any cap or limit in-place. The greater the margin, the higher house payments will be.
Adjustable-Rate Mortgage Holders Benefit from Low Interest Rates
The Federal Reserve has set interest rates at an historic low which means that an adjustable-rate mortgage holder can benefit from low house payments in the short-term. An ARM maintains the advertised rate for the 1, 3, 5 or 7 year period. Once this period elapses, a number of ARMs cap rate rises at 2% per year and 6% over the loans duration. In order for an ARM to be attractive, the rate of interest should normally be about 2% lower than a fixed-rate mortgage. If this isn't the case, the best mortgage deal is likely to be a fixed-rate offer, although a mortgage broker will be able to confirm this.
The Adjustable-Rate Mortgage - Short-Term Vs Long-Term
An ARM is likely to offer the best mortgage deal in the short-term. The interest rate on an adjustable-rate mortgage is normally lower than on a fixed-rate mortgage because the lender has greater certainty in terms of the direction rates are heading. A fixed-rate term is likely to offer a homeowner lower house payments over the medium to long-term. However, a prolonged recession could mean that an ARM offers an attractive rate of interest for an extended period of time.
Fixed-Rate Mortgage - Certainty Vs Uncertainty
Whilst an adjustable-rate mortgage offers certainty for a modest period of time, rates become variable once this relatively short term concludes. A 15-year fixed-rate mortgage offers a homeowner the security of knowing precisely what their house payments will be for the full duration of the loan. This method of borrowing money can help considerably with household budgeting, particularly if over-time and bonuses aren't as readily available.
An adjustable-rate mortgage is the best mortgage deal in the short-term, but the majority of homeowners are likely to find that a fixed-rate mortgage is cheaper over the long-term. Fixed-rate loans offer a higher degree of certainty with regard to house payments and this provides genuine peace-of-mind.
Sources
(May 8, 2009). "Weekly Mortgage Applications Survey." The Mortgage Bankers Association (MBA).
Disclaimer: This article in no way attempts to give legal or tax advice. One should consult a licensed attorney, tax advisor, or other qualified professional.
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