U.S. mortgage rates have risen in the aftermath of the presidential election, as potential homeowners face higher monthly payments amid a stagnant economy with slow wage growth.
The 5-year ARMs are attractive to consumers, especially first-time homebuyers because the interest rates are lower, helping you save more money each month compared to the traditional 30-year mortgage.
"You get what amounts to a fixed rate mortgage, but at a lower rate than the traditional 30-year fixed," said Greg McBride, chief financial analyst of Bankrate, a New York-based financial content company.
While lower monthly payments are appealing, the interest rates reset after seven years, and it can be difficult to determine how much they will increase.
"If your timetable changes, then you may want to reconsider the loan you have," he said. "You don't want to be in the position of facing rising monthly payments that squeeze your budget or jeopardize your ability to afford your own home."
Consumers on fixed incomes and saddled with student loans and credit card debt might opt for a 30-year fixed rate mortgage, because it represents "permanent payment affordability," McBride said. The principal and interest will never change because it is a fixed rate and can be easier to budget.
"It may not always be the optimal choice, but it is the safest choice," he said.
Adjustable rate mortgages can still be beneficial if homeowners take advantage of the savings each month and allocate it toward paying down debt or into an emergency fund.
"Even if you're still holding the 5-year ARM at the end of five years, that doesn't automatically turn it into a bad decision," McBride said. "You will have banked five years of savings relative to the fixed rate mortgage that can help you absorb any payment increases until you refinance or sell the home."Many consumers gravitate toward the 30-year mortgage, because the payments are stable and have been very low, said Jonathan Smoke, chief economist for realtor.com, a Santa Clara, Calif.-based real estate company. Others are seeking the 5-year ARM, because they are more likely to qualify for a mortgage.
Each lender utilizes a benchmark such as the 10-year U.S. Treasury or LIBOR rate and a margin, which is "what is added to the benchmark to determine your new rate," Smoke said. The loans also have a cap on how high any single rate change can be and also a ceiling on how high the rate can ever be, he said.
At the end of the five years, homeowners can choose to refinance to a lower fixed rate, but need to budget for the closing costs.
A lower rate upfront can be favorable for younger homeowners, but examining the ceiling rate and how it will impact your monthly payments is crucial.
"A mortgage broker or lender can help you walk through scenarios to determine if your timeline could benefit," Smoke said. "To help calm any nerves about just how high your payment could go, ask yourself if you are willing to exchange the initial seven year savings for how long you might keep that mortgage after the seven-year period is up."
Paying the premium for the peace of mind that your payments will remain static means that if interest rates rise several percentages in the next few years, you won't be faced with having to consider the lower rate options or lower priced homes and/or more money down, he said.
"That's why hybrids will likely become more popular in the future compared to how little they are used today," Smoke said.
Since people have a tendency to change homes every five years on average, a 5/1 ARM could be a good option because the savings can be substantial, said David Reiss, a law professor at Brooklyn Law School.
"Even if you are not planning to move now, the future may bring changes such as divorce, frail relatives, job loss or new job opportunities," he said. "Some people like the certainty of the 30-year fixed rate mortgages, but it is worth calculating just how much that certainty will cost you."
Here are the five lowest rates for a 5-year ARM, according to RateWatch, a Fort Atkinson, Wis.-based premier banking data and analytics service owned by TheStreet, Inc., which surveyed the majority of institutions in the U.S. from February 6 to February 13.
NBT Bank is headquartered in Norwich, N.Y. and offers a rate of 2.5%.
The Credit Union of Southern California is headquartered in Whittier, Calif. and offers a rate of 2.5%.
Point Breeze Credit Union is headquartered in Hunt Valley, Md. and offers a rate of 2.5%.
South Carolina Federal Credit Union is headquartered in North Charleston, S.C. and offers a rate of 2.5%.
The State Employees Credit Union of Maryland is headquartered in Linthicum, Md. and offers a rate of 2.5%.