With Mortgage Interest Rates on the Rise, Is an ARM Right for you?

BY: Cindy Mack

When trying to decide what loan program is the best for you, a basic decision is whether to go with a fixed rate or an adjustable rate mortgage.

Fixed Rate Mortgage

A fixed rate mortgage is a loan where the interest rate is fixed for the entire term of the loan.  With this type of loan, your monthly mortgage payment will remain the same throughout the entire term of the loan.  This gives you certainty that your payment will not be different 5 or even 10 years from now.

Adjustable Rate Mortgage (ARM)

While an Adjustable Rate Mortgage (ARM) is a loan where the interest rate is fixed for a certain time but will change after that fixed time.  The most common terms for the initial interest rate period are 3, 5 or 7 years.  ARMs are often described as 3/1 ARM, 5/1 ARM or 7/1 ARM.  These are typically 30-year loans.  The 3/1, 5/1 or 7/1 means the interest rate is fixed for the initial 3, 5, or 7 years of the loan and then will change each year after. 

When the interest rate adjusts, it’s not a random adjustment but based upon a margin and an index.  These terms can vary depending upon the financial institution.  A common margin is 2.625% with an index based upon the 1-year treasury rate.  So, if the 1-year treasury is at 2.66%, the new interest rate would be 2.66% + 2.625% = 5.285% rounded to 5.25%.  There can be caps built in that keep the interest rate from changing too much at once or over the term of the loan.  For example, if an ARM has caps of 2/5, the interest rate cannot go up or down more than 2% each time the interest rate adjusts and cannot go more than 5% over the initial interest rate during the term of the loan.  So if you have a 5/1 ARM at an initial interest rate of 3.50% the interest rate cannot go higher than 8.50% over the term of the loan.

Choosing The Right Mortgage

Given the uncertainty of the interest rate and payment, why get an adjustable rate loan?  A big reason is the difference in interest rate.  As fixed mortgage interest rates rise, the spread between the interest rate on a fixed rate loan and the interest rate on an adjustable rate loan is getting bigger.  It’s not uncommon for there to be a full percentage point between a fixed rate loan and an ARM.  This can save you a fair amount of money especially if you don’t feel you will be in the home for more than 5-7 years.  If this is the case, you may be selling the home before the interest rate would adjust. 

A good mortgage lender will ask you a few questions to help determine which loan would be best for you.  They will explain the options and let you decide what loan is best. Talk to one of the SBCP Mortgage Lenders, they can help you find the right mortgage.

Cindy Mack

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