Homebuyers have had a rough time lately. First, the frenzied housing
market stymied so many offers and caused frustration due to a lack of
inventory. Now that the pace and prices are starting to drop, interest rates
have ticked up to alarming levels. While some buyers are postponing their
purchase, those still in the market are starting to consider more creative
financing, including an ARM (Adjustable-Rate Mortgage).
What is an ARM?
Unlike a 30-fixed mortgage, as the name suggests, the interest rate of an
ARM can change over the course of the loan. The interest rate is based on
an index, such as the one-year T-Bill. Additionally, the timing of adjustment
is fixed in the loan documents, so the borrower knows how to plan for
changes. For example, a 5/1 ARM means that the initial interest rate is
fixed for the first five years and then can adjust once a year for the
remaining 25. Likewise, a 7/1 ARM has a fixed period of 7 years. There are
also built-in protections to ensure that the adjustments are reasonable.
These are limits to how high an adjustment (or reduction) can be
assessed at each point and an overall cap on the interest rate.
The advantage of an ARM is to allow more buying power to buyers by
starting with a lower interest rate than that available in a 30-year fixed loan.
This can be especially valuable for buyers who do not intend to keep the
home for 30 years; they can tailor the adjustments based on their planned
time to own the home.
The housing market is shifting. Homebuyers may not have the same
challenges as last year, but today’s market presents new issues. One tool
is an Adjustable-Rate Mortgage and with ever-higher interest rates, this
mortgage product may be making a comeback.