3 Times Experts Say Adjustable-Rate Mortgages Make Financial Sense
An overwhelming majority of homebuyers opt for fixed-rate mortgages. The terms of these loans offer all the warm and fuzzy feelings that come with a long-term, stable relationship. Go with a fixed-rate and your mortgage rate will be the same tomorrow as it is in 2049, and who doesn’t love predicability?
Already popular with many first-time homebuyers, fixed-rate mortgages solidified themselves as the darling of the mortgage industry following the housing crisis. Most people thought adjustable-rate mortgages (ARMs) were just a bad idea. Borrowers turned away from ARMs, fearing that once the rates reset, it could be difficult to keep up with housing payments, and thus put them at risk of foreclosures.
But adjustable-rate mortgages seem to be making a comeback. While they still are risky for a long-term investment, they have more safeguards in place than they did prior to the housing market crash, like how much and how fast a mortgage rate can adjust.
Here’s what the numbers tell us: In May 2019, adjustable-rate mortgages only made up 6.7 percent of new home loans, according to Ellie Mae, a software company that processes more than a third of the mortgages in the United States. But in December 2018, ARMs seemed to be mounting a comeback, making up 9.2 percent of new mortgages—the highest since Ellie Mae began tracking the data in 2011.
The biggest misconception about ARMs? That they should never, ever be used. In fact, there are circumstances when finance and mortgage experts say adjustable-rate mortgages actually make more sense a fixed-rate.
Recognizing that homebuyers have unique financial situations, we asked mortgage lenders when it makes sense to go with an adjustable-rate mortgage. Here, three situations in which they’d recommend an ARM.
But just a reminder before we delve into the scenarios : It’s a good idea to talk all this over with a home lending advisor.
1. You’ll move soon
First, an explainer on how ARMs work: The title of the loan lets you know when the interest rate can reset. So, if you get a 5/1 ARM, that 5/1 means the loan’s lower introductory rate will last for five years, and, after that, it’s subject to adjusting on an annual basis, Holden Lewis, NerdWallet‘s home expert explains.
It’s best to get an adjustable-rate mortgage when you feel confident that you will sell the home during the introductory period, or within a year or two of the end of the introductory period, Lewis says.
“So if you get a 5/1 ARM, the safest course is to do so if you expect to sell the home within seven years or so.”
If you’re buying your forever home, you could be subject to ever-increasing interest rates after the introductory period ends—unless you refinance, Lewis says.
Piggybacking on this, if you are buying a starter home and will want to upgrade within five years, an ARM may be a good fit.
Many people don’t consider their actual circumstances and take a fixed rate without giving thought to an ARM, Cohn says. “If you are a first-time homebuyer, newly married, growing a family—those are all reasons in my eyes to take an ARM as your housing needs will change as you go through life.”
Another great reason? You’re starting your career in an expensive city where rent is consistently going up, but you don’t plan on living there in your next chapter of life. In fact, the mortgage are more popular in high cost metro areas like DC.
2. Interest rates are low
Adjustable-rate mortgages are a great option in a low or declining interest rate environment. Typically, ARMs anchor to some publicly-available interest rate benchmark (such as LIBOR, Fed Funds rate, prime rate, etc.) and add a defined number of basis points to the overall rate offered to you under the ARM. If your ARM adjusts way higher than what you were paying, you can refinance to another ARM or a fixed-rate mortgage—whichever option saves you the most money. (Though sometimes refinancing can be out of the question if housing prices drop greatly—one of the problems that happened during the 2008 housing crisis)
3. You plan on paying off your mortgage quickly
An ARM could be a good fit if you plan on paying off the mortgage before the rate adjusts, says Kristopher Barros, marketing strategist at Embrace Home Loans in Middleton, Rhode Island.
“That is a less common scenario for a typical homeowner, but still a good reason to take advantage of the lower rates typically associated with an ARM,” Barros says.
Decisions, decisions! (But, again, before deciding, talk to a home lending advisor about your situation)
SOURCE: APARTMENT THERAPY