Ask Our Broker With Peter G. Miller: ARM Deal?
Question:
With mortgage rates rising during the past few months, is now the time to look for an ARM or is it better to stick with a fixed-rate mortgage?
Answer:
The attraction of getting an ARM is that the start rate, which might last for three, five or seven years depending on what product you choose, will be significantly lower than the going rate for 30-year fixed-rate financing. At the end of April, a 30-year fixed-rate mortgage was priced at 4.58 percent according to Freddie Mac. At the same time a 5/1 ARM was at 3.74 percent. Figures from Ellie Mae show that in March, ARMs represented 6.3 percent of the mortgage market.
If you borrow $150,000 at 4.58 percent interest, the monthly payment for principal and interest will be $767.17. With a 3.74 percent start rate the initial payment drops to $693.82. That’s a monthly savings $73.35 or $880 a year. After five years the ARM borrower is ahead by $4,400.
While the ARM is plainly a better deal during the first five years in this example the real issue is what happens after that.
If we’re talking about mortgage rates in the 5 percent range in 2019, then what might they be five years from now? We don’t know, but we do know that rates in the 4 percent and 5 percent area are very much below long-term averages.
However, let’s say our ARM has 2/2/5 caps. This means the initial rate increase after the start period end scan be no more than 2 percent, the interest rate can rise no more than 2 percent per year and the lifetime cap is 5 percent above the original start rate. By the numbers this means in year six the rate can go to as much as 5.74 percent, 7.74 percent in year seven and a max of 9.74 percent in year eight.
There’s no rule that says ARM rates must rise. However, if they do increase, the borrower is obligated to pay the new and higher cost – a situation that raises several questions.
First, are ARM increases a problem? If you sell the property within five years, then higher future costs are not a worry.
Second, if you refinance with a fixed-rate loan, you may not be able to get the 4.58 interest rate available in this example.
Third, if monthly costs increase, will payments be affordable?
For most people the small difference between fixed and adjustable rates is just not enough to create ARM traction.
Peter G. Miller is author of "The Common-Sense Mortgage," (Kindle 2016). Have a question? Please write to peter@ctwfeatures.com.
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