This Day On The Street
Continue to site
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

ARMs Still Have Their Place

NEW YORK (TheStreet) -- Adjustable-rate mortgages have been in Siberia for a few years, accounting for only a smidgen of new loans. But certain borrowers should now take a look, as ARMs currently charge significantly less than loans with fixed rates.

Just before the start of the financial crisis in 2007, the three-year ARM rate was about 6%, nearly identical to the rates on 30-year fixed-rate loans. Though the spread widened somewhat as rates fell in the years that followed, fixed-rate loans charged so little that the vast majority of borrowers chose their predictability over the risk of future rate increases they faced with adjustable-rate loans. ARMs typically reset every year after the initial period ends.

But things have changed. In November 2012, the average 30-year fixed loan charged 3.66% and the 3/1 charged ARM 3%. That 0.66-point gap has since widened to 1.5 points, with the fixed loan at 4.6% versus the ARM's 3.1%. For every $100,000 borrowed, the fixed loan would charge $513 a month, the ARM $427.

The ARM would save the borrower nearly $3,100 during the three years its rate was guaranteed, or $9,300 on a $300,000 loan. That's enough to get you thinking.

Must Read: How to Save When You're in a War Zone

Also, the lower rate would allow more of each ARM payment to go to principal, so that after three years the balance on the $100,000 loan would be $94,645, versus $95,109 on the fixed loan.

There is, of course, the standard downside of ARMs: the risk that the annual rate resets that start after three years would leave the borrower paying more than with the fixed loan. For the fourth and fifth year, higher ARM payments might merely erase some of the first three years' savings, but eventually the net cost of the ARM could well be higher. The bigger the rate hike, the sooner that would happen.

So ARMs are best for two groups of borrowers, first being those who don't expect to have their loans for very long -- say only four, five or six years. The upfront savings are guaranteed, the long-term risk removed by the short time horizon.

These may be borrowers who are transferred frequently or expect to trade up as their income or family gets bigger. Now that home prices are again rising, a short-term homeownership plan is not as risky as when they were flat or falling, because there's a better chance of selling the property for enough to pay off the loan balance.

The second group who might consider ARMs includes homeowners who can afford the interest-rate risk and believe resets will keep the mortgage rate low or make it lower. For now, that seems like a stretch, as it would be hard for resets to stay below the historically low 4.6% you can lock in with today's fixed-rate loans. ARMs reset by adding a margin, or number of percentage points, to an index, a widely used gauge of prevailing interest rates. Before getting an ARM, be sure to understand how this calculation will be done.

Also be sure to understand how "caps" would govern the ARM's maximum annual and lifetime rate increases. Get one only if you believe you could handle the largest possible payment increase.

Most borrowers will undoubtedly do best with a fixed-rate loan, locking in today's still-low rate for the long term. But ARMs do have their place, if you'll be a short-term borrower or have a stomach for risk.

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
SYM TRADE IT LAST %CHG
AAPL $113.29 0.33%
FB $91.01 1.43%
GOOG $630.38 -1.13%
TSLA $248.48 2.26%
YHOO $33.14 -1.63%

Markets

Chart of I:DJI
DOW 16,643.01 -11.76 -0.07%
S&P 500 1,988.87 +1.21 0.06%
NASDAQ 4,828.3250 +15.6170 0.32%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs