Since 2009, annual mortgage rates have been below 5 percent, and demand for adjustable-rate mortgages (ARMs) has been in the single digits. Ellie Mae reports that ARMs comprised just 5.6 percent of the marketplace in December 2017, up from 3.9 percent in November 2016. Why the new interest in ARM loans? There are few financial products that are easier to understand or a better deal for borrowers than the fixed-rate mortgage, where you lock in a mortgage rate for as long as 30 years and don’t have to worry about inflation and higher mortgage rates. Here, The Mortgage Reports suggests three questions to ask when you’re considering an ARM.
1. What’s the current ARM/Fixed spread?
When you’re shopping for a mortgage, the difference in mortgage rates between an ARM and a fixed-rate mortgage is known as the “spread.” The spread is your incentive for using an ARM rather than a fixed. The bigger the spread, the more attractive the ARM. For example, if you’re choosing between a 10-year ARM and a 30-year fixed, and the difference in mortgage rate is 12.5 basis points (0.125 percent), you may feel that there’s little reason to accept the risk of an adjustable-rate loan. However, if the spread widened to 50 basis points (0.50 percent) or more, you may start to change your mind. In general, the shorter your ARM’s initial teaser period, the lower its starting mortgage rate. A seven-year adjustable will have a lower starting mortgage rate than a 10-year adjustable; and a five-year adjustable will have the lower starting mortgage rate than a 7-year adjustable. The savings of an ARM can be substantial while it’s in its teaser period. After the ARM enters its adjustment period, however, savings can reduce or evaporate.
2. What’s your time frame in the house?
Another factor that determines whether you should consider an ARM is the length of time you plan to live in your home; and, the number of years until you might conceivably attempt a home loan refinance. According to the National Association of REALTORS, homeowners typically own property for about seven years before selling. Older homeowners tend to own for a few years longer, while younger and first-time home buyers tend to own for a few years less. This statistic, which is based on decades of data, suggests that many U.S. home buyers would be better suited to an ARM than a fixed. This is because a large majority of homeowners sell their home before their hypothetical ARM would ever begin to adjust. So, if you don’t consider your next home to be your “forever home,” see what kind of money you might save with an ARM.
3. Is your mortgage a jumbo loan?
A jumbo loan, by definition, is a mortgage loan that exceeds the loan size limits for an area. Loan limits vary by region, ranging from $453,100 to $679,650. If you want to borrow more than your area’s loan limit allows, there are mortgages still available to you. However, the fixed-rate pricing tends to deteriorate. The difference in mortgage rates between a fixed-rate loan within loan limits and one that’s outside of loan limits can be as high as 150 basis points (1.50 percent). For ARMs, however, jumbo loans can get inexpensive. It’s not uncommon to see jumbo ARM mortgage rates beat jumbo fixed-rate mortgage rates by 250 basis points (2.50 percent) or more. That’s a pretty big incentive to go with an ARM.