Homebuyers have had a rough time lately. First, the frenzied housing market stymied many offers and caused frustration due to a lack of inventory. Now that the pace and prices are dropping, interest rates have ticked 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 throughout the loan. The interest rate is based on an index, such as the one-year T-Bill. Additionally, the adjustment timing 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 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 and 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 intend to keep the home for less than 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 return.