How long has it been since anyone mentioned the phrase "adjustable rate mortgage?" A while, right? In fact so long that it almost falls into the category of "He who shall not be named," of the Harry Potter series of books. However, they do still exist, and just like Voldemort they have come creeping slowly back into usage. It seems there is a time and a place for adjustable rate mortgages.
I can't say that I have had a potential client ask for an adjustable rate mortgage since about 2009, when they turned into a four letter word of sorts, ARMS. Back then many high risk loans were adjustable rate mortgages. It wasn't only the adjusting interest rate that made them a bad bet, it was that they were sold to so many buyers who didn't have the means to make the payments when the loans began adjusting or credit that was good enough to obtain an adjustable rate mortgage that was more mainstream-a loan with less punitive adjustments.
Back in the bad old days of lending, when anyone with a pulse could obtain financing, adjustable rate loans were included in a category of loan referred to as subprime-meaning that the borrower didn't qualify for any of the mainstream products. The terms on these loans were harsh. The first one, three, or five years were fixed, but after that, Katie bar the door, these loans could increase by five, eight, or twelve percent at six month intervals. To further magnify the problem most of the borrowers for these loans were qualified at the lowest interest rate-or-the loan was a stated income loan in which the borrower could state their income which might or might not be a true representation of what the borrower actually made. So you can see some red flags along the way here and why things might not work out in the end.
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Once the immediate crisis had done its damage we can safely say there was no appetite for adjustable rate mortgages at all. None. And since interest rates were being kept low by the Fed with monetary policy, there was no reason to be particularly interested in obtaining one since a great rate could be had on a thirty year fixed rate loan. However, the mainstream adjustable interest rates never went away. All those 5,7 and even 10 years adjustables just kind of hung out waiting for the climate to change.
For those who aren't familiar with an ARM product, here is how they work. The rate is typically lower than a 30 year fixed rate. For instance if today's thirty year fixed rate was at 4.375% the 5 year adjustable might be at 3.375 (as it is today). So what happens is that the rate is fixed at the low rate for 5 years at the expiration of which it can begin adjusting once a year every year. It is true that the rate can also go down but I think it is safe to say that given the current state of affairs interest rates-all of them will begin to increase in the very near future. (Since the Fed has actually named a date that it will stop buying mortgage backed securities and treasury bonds-which affect rates.) So that same 5/1 ARM will begin adjusting, most likely upward in the sixth year.
So why would anyone bother with that? Well, because the more things change, the more they stay the same. And one thing that has remained fairly consistent in recent years is a statistic of how long the average American owns the home they are in. Americans move every five to seven years. And in many cases they move from one region of the country to another. Many people accept certain employment knowing that they may not stay where they are currently located. Do you see what I am getting at? If you know that you will be moving inside of seven years, why not get a lower interest rate?
The conforming ARMS do have caps on them-for instance, the 5 year can change no more than 2% annually but it can go up 5% over the lifetime of the loan. So in the 6th year the 3.375% can and probably will go up to 5.375% but it can't increase to more than 8.375% over the course of the thirty years on the loan. 8.375% may sound outrageous if you plan to be in your home for quite some time-but for those who know they will be gone before the rate has a chance to go that high an adjustable rate may seem like a good idea.
If you think you are in a situation in which an adjustable rate mortgage might work for you be sure to get all the facts. Don't be afraid to ask your loan originator about the caps on the loan-when and how much the adjustments might be. While this type of mortgage is another tool in the tool box, like any other implement, it is important to know when you need a socket wrench as opposed to when you need to use a screw driver.
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