Adjustable Rate Mortgages are Not Evil
I pulled the familiar looking envelope out of the mailbox knowing exactly what it was. Would it contain good news, or bad?
Nine years ago this month we moved into our home. It was at the peak of the housing boom, and mortgage lenders used creative financing to put borrowers into as big of a house as possible. We financed our home with an Adjustable Rate Mortgage (ARM) product they called the Builder’s Best Loan. We started at an interest rate of 3.25%, which would remain constant for 5 years. After that, every year on the anniversary of the inception of our loan, it would adjust based upon the interest rates at the time.
When I tell people we have an ARM, the common reaction is that I need to refinance with a fixed rate mortgage pronto, as if my life depended on it. The perception is that ARMs are bad, and that they will cause your interest rate and monthly payment to go up resulting in an unaffordable payment.
That just hasn’t been my experience.
In the four years that our mortgage has adjusted, it has always adjusted down resulting in a lower monthly payment. In fact, my mortgage payment today is less than it was the day we bought our home even though our property taxes are significantly higher.
I did a little investigation to determine what would happen to my mortgage payment if I decided to refinance my home today with a 20 year fixed rate loan (since I have about 20 years left on my current loan). The current interest rate offered by my bank for that term is 3.375% and according to my bank’s refinance calculator I would incur closing costs of about $5000, and have a monthly payment of about $100 higher.
I would pay close to $5000, for the opportunity to pay $100 more in interest each and every month. Why would I want to do that?
I opened the envelope and read the letter, but I already knew what it was going to say. I had researched how my interest rate is calculated a few weeks earlier, and knew my interest rate was staying exactly the same for the next twelve months.
I will continue to watch interest rates, and if the time comes where it makes sense to refinance my home I will. But until then, I’ll keep my 2.875% interest rate thank you very much!
What are your thoughts on ARMs? Do you have one? How is it working for you?
Brought to you courtesy of Brock
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Brock is a software engineer by day and personal finance blogger at night. He is a fitness junkie and enjoys grilling and smoking meat. Married with two children, Brock strives to improve his skills as a husband and father, and is always on the lookout to stretch his family’s budget as far as he can.
I have a great 2.29% ARM at the moment, and fixing would be at least 3%. I may consider a fix if the rates go up 2-3 points but it is too cheap right now to do so.
In my experience, there are two types of ARMs.
Those that are insane – interest-only, teaser rate, etc. A $400K 1% interest-only is $333/mo. Cool, huh? Now, adjust it to 4%/30 year, and it’s $1910/mo.
Then there are those that are sane – like the above, except at 2.875%, the payment is $1660. You can see, even a jump to 4% is only $250 more, a 15% higher payment, not Six Times the payment.
No Brock, ARMs are not evil. But there’s a special place in hell for the sellers of the first type of ARM I described. And those ARMs played a key roll in the real estate bubble and subsequent melt down. Nice article, glad you were not an April Fool’s joke.
@Pauline – I thought my 2.875% was good, I’m freaking jealous of your 2.29!!!!
@joetaxpayer – I had a neighbor that financed his house with an interest only loan….I’m not sure in what world that seems like a good idea – it’s essentially paying rent with the potential for your rent to be jacked sky high. I had a neighbor who financed his home with an interest only loan. He’s now trying to sell it, but can’t unload it and doesn’t want to sink the money into refinancing because he is optimistic about selling it. Seems like a ticking time bomb!
Thanks for reading and commenting, Joe….glad you came back to make sure I was a real. Haha!
We’d go ARM if it would let us pay off the house in 10 years or less. Right now, I’d keep an ARM until the Fed starts raising rates. Why not take advantage of historically low rates now?
@Jenny – exactly! That’s what I keep telling people that insist I need to dump my ARM for a fixed rate loan. I do get their attention when I tell them what my interest rate is though, because it’s significantly lower than theirs. 🙂
Yes, all good points. When you get an ARM you should know the index the ARM is pegged to, the margin rate above that index your interest will be, and how often it resets. I agree that it’s more important to know the terms of your loan, than to run away screaming when someone says, ‘ARM’.
It sounds like you have a reasonable marginal rate, and it’s good that the rate resets only every 12 months. The evil loans Joe Taxpayer is talking about have a high margin, reset as frequently as every month, and are probably pegged to a shorter-term index like the 1-month LIBOR.
There is a world for interest-only loans but it is sparsely inhabited. It’s for people who may have uneven income, large bonuses, nearly guaranteed future higher income, and/or could pay it off if they want to but have better things to invest in. Yes, it it like renting, but with a big tax deduction. Not for everyone
@Rob – wow, I had no idea there were ARMS that would reset every month…that’s CRAZY! I can see how an interest only product would work best for someone with uneven income as they would want the lowest payment possible. BUT, one would have to have the discipline to put large chunks of cash towards the mortgage when they became available. Otherwise you’d never make any progress on paying it down. Thanks for your comment!
Excellent comments and post about ARMs and I agree with most of what you say. I will be sending some of my clients here who have questions about these types of mortgages. Thank you for sharing!
Austin.
I appreciate it, Austin – thanks for stopping by!