It’s common to refer to two varieties when speaking about mortgages—fixed rate and adjustable rate—almost out of habit. But the truth is that adjustable rate mortgages, or ARMs, haven’t been popular for some time. If you go back to 2005, nearly 40 percent of mortgages originated were adjustable rate. Ten years later, in 2015, and only 5 percent of mortgages were ARMs.
They aren’t done yet, however. In fact, 2017 may be the year that adjustable rate mortgages make their big comeback.
Learn more about the facts behind an ARM, and why it matters in context with the current economic conditions, to understand why this variety of mortgage could benefit you in buying a new home during 2017.
1. Most ARMs are actually Hybrid ARMs
A Hybrid ARM is a mortgage that opens with a fixed rate for a predetermined period, and then the rate fluctuates based on the market for the rest of its life. These fixed periods typically stretch between three, five or even ten years. These are expressed as “3/1,” “5/1,” “10/1,” etc.
WHY IT MATTERS IN 2017
ARMs have always been popular for people who don’t plan on staying put for too long. The opening fixed period of an adjustable rate mortgage is usually lower than the the going fixed rate. Therefore if they planned to stay for around five years, they could take advantage of an ARM—paying lower rates until they sold the home five years down the line.
This backfired following the banking crisis. Many homeowners who had planned to sell after the fixed period expired found that no one wanted to buy. Demand for housing was too low, and they were stuck with the adjustable rate.
Only one thing has changed in 2017, and it’s a big one: Demand for housing is back. Barring another dramatic shock to the U.S. economy, using ARMs for a shorter residence at a home could once again save you a lot of money in the short term.
2. Run The Spread
As we suggested above, there’s a difference between the rates offered for a conventional fixed rate mortgage and the the rate offered for the beginning of a Hybrid ARM. This difference is known as the “spread.” Typically, the temporary fixed rate on an ARM is lower than that of a conventional 30-year fixed rate mortgage.
WHY IT MATTERS IN 2017
The risk with taking an ARM is that you’ll be stuck with the going rate after your fixed period ends. At times last year, you could have gotten a 5/1 ARM with an opening rate of 2.75 percent. That’s nice, but you have no way of knowing what the rate will be for the next 25 years. Compared to that, just going with the 3.25 percent 30-year fixed—which was available at the same time—doesn’t seem like a bad move. A spread of .5 isn’t worth the risk, in the eyes of many.
According to Freddie Mac, as of publication, an average 30-year fixed rate mortgage could get 4.25 percent, compared to 3.33 percent for a 5/1 ARM. That’s almost a whole percentage point; much more worth the risk. The odds are much better that your initial savings will offset the cost across the life of the loan. Keep reading and you’ll see how refinancing can also make ARMs an effective savings tool, even if the adjustable rate increases.
3. ARMs start lower…and you can strategize to avoid dealing with high adjustable rates
Many people are still scared of taking on an ARM mortgage because of how unpredictable rates can be further on down the line.
WHY IT MATTERS IN 2017 (or any year)
This inherent risk is why many people opt for a fixed-rate loan, especially if they believe the economy might be in a bad place five years down the line. However, there’s an effective strategy that can help you avoid dealing with market rates, even after your fixed period is finished.
Obviously you’ll be saving cash for the first five years of your 5/1 ARM (or however many years the fixed rate remains). You can utilize those savings to save yourself even more money down the line. One idea is to take those savings and make extra payments toward the principal of your mortgage. The majority of the amount you pay across the life of your loan will be interest, so the more principal you can pay off at the onset, the less you’ll need to pay later. When you get to the end of your ARM’s fixed period, you can refinance into a fixed rate. The payments will be lower because the principal itself is lower.
So is an ARM the best option for you during 2017? Your personal situation will make the biggest impact. Speak with a lender and find out what you should be looking for in a mortgage!