Health & Fitness
When Does an Adjustable Mortgage Make Sense
With interest rates currently on the rise, many buyers and homeowners are asking, “Does it make sense to do an adjustable mortgage (ARM)?” The answer is: “It depends.”
These days few homeowners (especially first time homebuyers) stay in their home for more than 7 years. In this case it often makes sense to get an adjustable mortgage if the borrower only intends to live there short-term. The initial rate on an ARM is significantly lower than a fixed mortgage. If the borrower takes out a 5 or 7 year ARM and plans to move, they won’t have the loan long enough to be concerned about the rate fluctuating.
ARMs are available for initial fixed periods of 3, 5, 7 or 10 years. Once the initial period has elapsed the rate adjusts annually thereafter. The interest rate you pay after the initial period is over depends on three factors: the margin, index, and caps. The margin is the fixed portion of the adjustable mortgage. For the duration of the loan it remains the same. The index is the variable portion. One of the most common indices for ARMs is the Libor Index. When an ARM is no longer fixed the new interest rate is determined by adding the margin and index. The last component is the caps. Caps limit how much the interest can move over time. The annual cap determines how much the rate can change annually and the lifetime cap gives a worst case scenario of how high the rate can be for the life of the loan.
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Here are some questions you should think about if you’re contemplating an ARM.
- How long do you anticipate living in your home?
- Do you expect any changes over the next few years such as your family expanding, having children go off to college, or even move away?
- Do you expect any changes in income due to promotions, relocations, retirement, or pension?
- Is your intention to take advantage of the lower initial rate to pay down your mortgage earlier than a fixed rate mortgage?
- Are you certain you will be selling the home before the fixed initial period of the ARM expires?
Let’s consider the following example: a 5 year ARM today for a loan of $250,000 is at 3.250%. The monthly payment for principal & interest is $1,088.02. For a 30 year fixed with a rate of 4.500% the monthly payment for principal and interest goes up to $1,266.71. The monthly difference is $178.69. If this savings is carried over several years it would be in the thousands.
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Your mortgage is a pivotal component to your overall financial planning strategy. We are here to assist you with all your mortgage needs. Contact us for a free consultation.
Priscilla Land
Prestige Mortgage Corporation
130 N La Grange Road, Suite 101
La Grange, IL 60525
Equal Housing Lender| Illinois Residential Mortgage Licensee
License# 031.0024214| NMLS# 137686
