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ARMs: When an Adjustable Rate Mortgage Is Appropriate

The Right to Bear ARM's

The Right to Bear ARM’s

Orange County, CA – You have the right to bear ARM’s! With mortgage rates moving higher,  adjustable-rate mortgages are becoming more attractive. An adjustable-rate mortgage (ARM) is a mortgage that, in general, begins its life with a low fixed rate. After that period, the mortgage rate is reassessed at regular periods of time based on the market conditions.

For example, let’s say you have a 7/1 ARM with caps of 4% and 1%. This means that your mortgage will have a fixed interest rate for seven years. After those seven years are up, the rate will adjust automatically every one year thereafter. At the beginning of the 8th year, the rate can adjust up or down as much as 4%. 4% is also the maximum amount upwards or downwards that the rate can ever change. Each year thereafter, the amount can go up or down by as much as 1%, as long as it stays within the 4% lifetime cap.

When you’re looking at acquiring an ARM, there are three conditions under which it can be a great idea.

  1. You intend to sell your home before the initial rate expires.
  2. You believe you will be in a strong position to refinance your home before the initial rate expires.
  3. You believe that the market will weaken (i.e. mortgage rates will go down) by the time the initial rate expires.

Please keep in mind that all three of these situations are gambles. You may not be in a position to sell your home or refinance when the rate change happens. And trying to predict the market is an even greater challenge, especially when you’re looking a half-decade or more into the future. But if you’ve got a particularly strong plan an ARM can be an intelligent choice to make. For example, you know for an absolute fact that you’re going to move out of the state in 4 years. Then you can benefit from the lower initial interest rate that an ARM offers. Why pay a higher interest rate for a 30 year fixed loan if you know you won’t have the property for that long?

That said, it’s never ever a good idea to take out an ARM if you absolutely cannot afford the worst-case scenario. For example, if you accept an $800,000 loan at 4.000% on a 7/1 ARM with caps of 5% and 2%, you’re looking at a monthly payment of about $3,800. But at the beginning of the 8th year, you could potentially be looking at a payment of $6,400. If interest rates have climbed staedily over that 7 year period it’s possible that your rate will increase the entire 5%. If that kind of payment would bankrupt you, there is no way you should ever accept that mortgage. You always need an out. In that case you may be forced to sell the home.

On the other hand, if you are fairly certain that you’ll be able to shed the mortgage before the rate adjusts or that rates will decline, an ARM can be a great way to save a ton of money. Compare fixed rate and adjustable rate mortgage payments here: 

ARM’s are not for everyone. Contact us to discuss if an ARM is appropriate for you.

Scott Storace

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