September 9th, 2019 4:08 PM by Jackie A. Graves, President
The average introductory
interest rate on a five-year ARM is 3.35%.
That’s still lower than the
average 3.9% on traditional 30-year fixed mortgages, although the spread has
It’s also important to
consider the fees and points you pay to the lender at closing.
If you’ve been considering a mortgage with an adjustable rate,
your reasons for going that route might be disappearing.
recessionary fears cause longer-term interest rates to hover near or below
short-term rates, the advantage that typically comes with adjustable rate
mortgages has shrunk — or entirely disappeared — at some lenders. ARMs, as they
are called, are based on short-term interest rates compared with fixed-rate
mortgages’ reliance on longer-term rates.
would say that if you only plan to own the house for, say, five years, maybe
you could do a five-year ARM if rates are lower than a fixed rate — which they
usually are,” said Ed Snyder, a certified financial planner and cofounder of
Oaktree Financial Advisors in Carmel, Indiana.
“But if you
can find a fixed rate that’s lower or the same as an adjustable, even if you
only plan to own the home for a short time, I can’t see why you would consider
an ARM,” Snyder said.
At last count, 6.4% of mortgage loan applications were for ARMs,
according to the Mortgage Bankers Association.
introductory interest rate on a five-year ARM is 3.35%, down slightly from
3.43% a week ago, according to the Mortgage Bankers Association. That remains
lower than the average rate on a traditional 30-year mortgage of 3.9% for loan
balances of $484,350 or less and 3.88% for those above that (so-called jumbo
loans), although the spread has shrunk.
The slide in mortgage rates comes amid continually rising home
prices. The median price of homes listed for sale has reached $289,900 and the
median price of sold homes is $235,500, according to Zillow. The company
forecasts prices to climb by 2.2% over the next year, compared with a 5.2% gain
over the last 12 months.
If you do find an ARM that looks better than a fixed-rate
mortgage, there are some aspects of the loan you should understand. For
starters, the initial rate is only fixed for a set number of years (i.e.,
generally three, five, seven or 10 years).
the rate could change. That uncertainty makes an ARM a riskier proposition than
a fixed-rate mortgage.
“If you go
with an adjustable rate for whatever reason, that rate could adjust up later,
instead of down,” Snyder said.
adjustment that kicks in after the initial fixed-rate period is based on a
widely used interest-rate index, along with the specific terms of your loan.
Commonly used benchmarks include the one-year Libor, which stands for the
London Interbank Offered Rate, or the weekly yield on the one-year Treasury bill.
Mortgage lenders also add an
agreed-upon percentage point (called the margin) to arrive at the total rate
you pay. So at the beginning of the loan, if the index is at 1% and your margin
is 2.75%, you’ll pay 3.75%.
After the end of the guaranteed rate,
say the index is at 2%. Adding your margin would mean paying 4.75%. And if the
index had jumped to, say, 5%? Whether your interest rate could jump to 7.75%
(5% index plus 2.75% margin) depends on the specific terms of your loan.
An ARM generally comes with caps
on the annual adjustment and over the life of the loan. However, they can vary
among lenders, which makes it important to fully understand the terms of your
mortgage (see common terms below).
adjustment cap. This cap says how much the interest rate can
increase the first time it adjusts after the fixed-rate period expires. It’s
commonly either 2% or 5% — meaning that at the first rate change, the new rate
can’t be more than 2 (or 5) percentage points higher than the initial rate
during the fixed-rate period.
adjustment cap. This clause shows how much the interest rate can
increase in the adjustment periods that follow. This number is commonly 2%,
meaning that the new rate can’t be more than 2 percentage points higher than
the previous rate.
adjustment cap. This term means how much the interest rate can
increase in total over the life of the loan. It often is 5%, meaning that the
rate can never be 5 percentage points higher than the initial rate. However,
some lenders may have a higher cap.
Additionally, even if you plan to
sell the house before the initial interest rate expires, you should factor in
the fees and points you pay to the lender at closing. (One point is equal to 1%
of the mortgage amount).
For illustration purposes only:
Say you plan to finance $200,000 and you could get a fixed-rate mortgage with
4%, or an ARM with 3.5% guaranteed for the first five years. After five years
with the fixed-rate loan, you’d pay about $44,760 in interest. With the ARM,
you’d pay $38,975 — a savings of $5,785.
However, say the 4% fixed mortgage
came with no extra lender costs at closing, but the ARM did. If that amount
were more than that $5,785, you wouldn’t come out ahead at the five-year mark.
Even if your initial interest rate
is palatable, make sure you know the highest payment you could be liable for if
rates rise and you have neither sold nor refinanced before the end of the
guaranteed rate. A Truth in Lending disclosure, which your lender must give you
within three days of your loan application, should include this information.
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