ARM Loan Programs

ARM Loan Programs

You may have heard that adjustable-rate mortgages are a great way to purchase a home at cheaper rates. An adjustable-rate mortgage starts with a lower than average payment, but that payment increases over time. Adjustable-rate mortgages are similar to variable-rate mortgages, but with a notable difference: adjustable rate mortgages change the amount you pay based on interest changes.

Adjustable-rate mortgages have frequently been used by home buyers who are not able to afford a home under a fixed-rate mortgage. They may also be used by home buyers who intend to sell their home within a certain period, or who intend to refinance their home.

How Does an ARM Work?

An adjustable-rate mortgage begins with a low, fixed interest rate at the beginning of the mortgage’s term. At the end of this introductory term, interest rates will go up, and the mortgage costs will go up. A 7/1 adjustable-rate mortgage would have a low, fixed interest rate for the first 7 years. After those 7 years have passed, interest rates will be adjusted based on the current market. This can cause a dramatic increase in the amount that the borrower is paying for their mortgage.

Using an ARM can make a property more affordable, as the interest costs are calculated into the amount you can afford for housing each month. When using an ARM, the assumption is that either: you will increase your earning potential, you will reduce your other debts, or you will refinance your mortgage (or sell your home) before the interest rates go up.

Adjustable-rate mortgages are more common when interest rates are high because they allow borrowers to procure a lower interest rate with the hopes of being able to refinance later on. Many borrowers may acquire an ARM with the idea that they will improve their credit and income picture later. However, ARMs are at higher risk to the bank, because there is an increased risk of default when the rates go up. Consequently, the interest rates are higher overall.

What Are the Advantages of an ARM?

Adjustable-rate mortgages are extremely useful tools for those who want to save on interest during the first years of their loan. As long as the borrower would be able to pay for the later increases in interest, there’s minimal risk. If the borrower can refinance their mortgage before the rate is adjusted, they will be able to avoid a sharp increase in their mortgage payments.

In areas with hot real estate markets, ARMs let borrowers get into the market quickly. Borrowers who are hoping to build equity may be better served getting into the market fast, rather than trying to wait for more income and a larger down payment. Borrowers who believe that they’re going to be able to improve their credit standing and income picture significantly in the future can bank on this and may be able to get the home that they want now rather than waiting.

However, an ARM isn’t without risks.

What Are the Disadvantages of an ARM?

Primarily, the risk with an ARM is that a home buyer could end up with a dramatically increased mortgage payment that they are not able to pay. There are several situations in which a borrower might find themselves unable to pay the increased amount, and unable to qualify for refinancing. In this situation, the borrower could need to sell their home, or walk away from the loan.

During the mortgage crisis, borrowers with ARMs had difficulty refinancing because they were underwater on their homes. This wasn’t something they could have anticipated or planned for, but it meant that they ended up with much higher mortgage costs than they expected, and they were unable to use another mortgage to avoid those costs.

However, if a borrower can pay for the increased mortgage amounts, then an ARM can make a lot of sense. An ARM lets a borrower purchase a home for a guaranteed, low fixed interest rate for a guaranteed period. As long as the borrower can refinance or sell the home within that time, the buyer is not necessarily saddled with the increased interest rates.

ARM loan programs are only one of the many loan programs that are available for borrowers interested in securing a home. With as many loan programs as there are, virtually any borrower can find the one that’s right for their financial situation. With ARM loans and variable rate loans, the amount that is being paid towards interest (and the equity that is being built) may vary, but it’s possible to save money over time with the right planning. A mortgage officer can help determine the right plan for you.