Adjustable Rate Mortgages

Adjustable Rate Mortgages – Still a Good Buy?

Adjustable Rate Mortgages have gotten a bad name recently. Although many people are shying away from Adjustable Rate Mortgages these days by equating them with subprime problems, that may be too conservative a position. What is an ARM Mortgage Loan? It might just be right for you.

Look at buyers’ situation any time you’re talking about an adjustable rate mortgage. There are safe adjustable rates that don’t adjust every month. The best ARMs actually offer a fixed rate for five years and then adjust every year thereafter. That may be good if this is the buyers’ first house and they plan to stay for less than five years — as long as they don’t base their decision solely on their ability to sell them. That can save them a quarter, a half, or three quarters of a point on their interest rate by pursuing this arrangement.

Buyers also need to understand how a 30-year or a 15-year fixed rate loan term affects payment amounts and total loan interest costs. Today, the interest rate difference between the two has shrunk because there isn’t as much demand for a 15-year mortgage as in the past. But buyers will still build equity faster with a 15-year mortgage and pay a lower interest rate than with a 30-year loan.

Also, it’s good advice for buyers to ask about points, which are upfront fees based on a percentage of the loan amount. A lender charges points to originate the loan and as an offset for lower interest rates. One point equals one percent of the loan amount. The use of seller financing—in which the seller agrees to take a promissory note from the buyers for the purchase of the sellers’ home—has dropped because fewer sellers can finance the sale of their current home and buy another. However, if buyers are creditworthy, it doesn’t hurt to ask whether sellers have the means to swing a seller-financed transaction.

While all this seems like a lot of complicated math, the Internet is full of mortgage calculators, making it easy for buyers to determine how large a mortgage they can afford and what their monthly payments at different loan amounts will be. If buyers haven’t done these estimates online, you can also suggest using some standard rules of thumb to estimate how much of a home they can afford. Monthly mortgage payments (including property taxes and insurance) should not exceed one-third of monthly gross income. The ideal range is between 28 percent and 33 percent of gross monthly income. Total monthly debt payments (including your mortgage payment) should not exceed 36 percent of total gross monthly income. The price of a home should not exceed 2.5 times total gross income. But before buyers can start plugging in numbers to a calculator, they need a clear picture of their current financial picture, so perhaps a visit with an accountant or banker is in order.

Borrowers with “hybrid” adjustable rate mortgages are finding themselves in a tough situation. Many of the loans are re-setting to levels that are lower than the initial fixed rates because the yields on some common benchmarks used for resetting ARMs have dipped to their lowest levels in decades. As a result, many ARM borrowers must decide whether or not they should refinance to lock in a good rate for the long term or keep their ARM’s current rate that is even lower right now but that could spike once the economy rebounds.

Whatever the case it’s clear that buyers shouldn’t rule out any financing, including an ARM Mortgage Loan completely until they’ve done their homework on what is available, and what they personally can wisely afford. Whether you’re looking at a fixed rate mortgage, or an adjustable rate mortgage that much stays the same.