The National Association of Realtors (NAR) has reported an increased demand for adjustable-rate mortgages (ARMs) as conventional home loan rates continue to surge, hitting a record 8% last month, the highest since August 2000. The current ARM rates are fluctuating between 7.12% and 7.65%. ARMs, which are available in four forms—3, 5, 7, or 10 years of fixed interest rate—transition into a floating-rate period where the mortgage rate adjusts based on market conditions.
A typical example is the 5/6 ARM that locks in the rate for five years before biannual adjustments. According to NAR, ARMs can be beneficial for homebuyers planning to sell during the fixed-rate period or those with unstable income sources. With today’s 8% interest rate, a $394,000 home (NAR’s median price) would cost about $2,891 per month using a 5/1 ARM. However, this cost could potentially escalate to $3,720 if rates soar to 12% in 2028.
While ARMs offer short-term savings due to lower initial rates than conventional loans, the unpredictability of future rates makes long-term savings uncertain. Financial advisory platform NerdWallet has cautioned those desiring steady monthly payments to consider potential rate fluctuations inherent in ARMs.
ARMs switch from a fixed-rate term to a variable rate based on interest rate indexes plus a margin added by the lender, with caps on rate hikes. There are several types of ARMs including 5/1, 5/6, 7/1, 7/6, 10/1, 10/6 ARM, payment option ARMs, interest-only ARMs, and convertible ARMs. Lower initial rates and flexibility are among the advantages; potential rate increases and budgeting difficulties are the downsides.
Lenders assess factors such as credit score (with a preference for a FICO score of 620), income, and debt history, and usually prefer a 5% down payment for approval. Some ARMs feature a “teaser rate” that can increase future payment risk. Refinancing an ARM into a fixed-rate mortgage can lead to penalties and closing costs.
As mortgage rates reach a 20-year high, it’s crucial for potential borrowers to consider prepayment penalties and ask for offers with zero points when comparing ARMs. Currently, there’s less than a 1% difference between the 30-year fixed mortgage and a 5/1 ARM’s introductory rate. Principal and interest payments and conversion options should also be considered when choosing an ARM.
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Source: Investing.com
