Adjustable rate mortgages (ARMs) have gotten a bad name in past years. Too many people were financed with little consideration about what would happen when the initial rate was upped. It was a case of creative financing that got a lot of people into big trouble and was the cause of many foreclosures. Yet, there may be some times when an ARM is a good idea for certain people.
What Is an Adjustable Rate Mortgage?
In an adjustable rate mortgage, an initial rate is set for the first few years. At regular intervals after that time, the mortgage holder is allowed to change the rate based on one or more indices. Examples of indices used are the US Treasury index and the Federal Home Loan Bank’s 11th District cost of funds index.
Why ARMs Got a Bad Name
The attractive thing about ARMs is that they tend to start out with a low introductory rate that is a lower rate than you would usually get on a fixed rate mortgage. The trouble in the past was that people were being financed who could just barely make the introductory rate with no room in their budgets to stand up to any later increases.
What Makes ARMs Better Now?
ARMs are less common now, especially since so many homeowners got burned. The difference now is that there are more stringent rules about the financial capabilities of loan applicants. Home buyers are more cautious, too. Now, people are more likely to think hard before they jump into an ARM.
If you plan to stay in your home for the rest of your life, it makes sense to cash in on a low fixed prime interest rate. Over the course of your life, the rate is bound to go up and you would be locked in with a low rate.
However, if you are thinking of moving within the next few years, it might pay to look into an ARM. The reason is that the initial rate is usually lower than fixed rate mortgages. If you will be moving soon, you might as well take advantage of that lower rate before you go.
The term “Jumbo Loans” sounds like it refers to multimillion dollar mansions. The truth is that jumbo loans now start at less than $700,000, which is not unreachable for many families. You might ask, what does this have to do with ARMs?
The thing to understand about jumbo loans is that many people plan to pay them off quickly. This is especially true of the larger loans taken out by the wealthy. It is also the case when families have some large income coming in soon, such as an inheritance or settlement.
Again, if you are going to be paying off the house soon, the ARM offers a distinct benefit for those first few years. In larger loans such as jumbo loans, the homeowner can save hundreds of dollars every month on their payments.
The main thing to beware of is getting into a loan that you cannot manage to pay if you are not out of the home when the rate goes up. An ARM might make sense for some people, but it never makes sense to overextend yourself. Be smart, but be careful too.