When does and Adjustable Rate Mortgage Make Sense?

When does an adjustable mortgage make sense?

In my 20 years as a real estate agent and broker I have found one of the most commonly misunderstood aspects of real estate lending is the adjustable rate mortgage. For the sake of this article I am going to be focusing on the Five year Fixed FHA Adjustable rate mortgage (we will call this an ARM for the rest of the article). This is a blend between a fixed rate mortgage and an adjustable mortgage.

When choosing a mortgage it is always important to consider how long you intend to be living in the home, what your income is likely to look like 5 years down the road, and where loan rates are likely to be in the future. Another important factor especially in the lower price ranges is even in a worst case scenario is your future payment more than the rent you are paying today.

One reason to choose this type of loan may be that you have some debt that will be paid off within a few years that is holding you back from qualifying using a 30 year fixed loan. Using the Adjustable Rate Mortgage that is fixed for 5 years allows you to qualify for more today and still be able to afford any future payment increases assuming that debt is paid off before the adjustment period. Also, many times a buyer has predictable wage increases based on seniority or advanced training that will be completed by a certain date.

Often buyers assume that the rate is guaranteed to go up. This is not always the case. Lets look at the 5 year fixed ARM. This is based on the 1 Year Treasury Bill a profit margin is added to this base rate and that becomes the basis for the potential adjusted rate. By looking at the last ten years and doing some math we can see that the rate will not necessarily always go up.

In this type of loan the rate is fixed for the first 5 Years. It can adjust after 5 years, but no more than 1% per year with a maximum 5% increase in rate.

Using an example from a client this week her loan would be $84,572 her start rate would be 4.25% for the first 60 months with and APR of 3.9995%
And an estimated total payment of $615.82 a month. In the worst case scenario
the maximum rate could go to 9.25% by year 10, but how bad does that really look? The maximum total payment at 9.25% in this example is $842.88. This
is less than what the property can be rented for right now.

After 5 Years the rate is calculated by adding 2.03% to the T-Bill Rate-The T-bill today (02/21/11 is .003% (less than 1%). Today's rate would make the interest rate less than the start rate if the loan was to adjust today.

The payment only goes up if the T- Bill rate goes up. The T-Bill has not been over 5.22% since July of 2006.

If you want to play it safe you can bank the difference between the lower payment for the first five years and use it later when and if the payment rises.

Make no mistake about it there are bad adjustable rate loans out there, but in
some circumstances these loan make a lot of sense. These are also really a good option for those with a 5-7 year hold strategy.

I have nearly the exact same loan on my own home. My loan is a 7 years fixed at 4.5%.

Ron Benning can be reached at (916) 730-3846 if yo have additional questions.
Ron Benning

Would you like to buy some Cherries? This simple question became the starting point for Ron Benning’s career in sales. He was only eight years old and was trying to earn enough money to buy a G.I. Joe. His parents wanted him to learn the value of a dollar & decided to have him save his own money to buy it. Since they lived near several cherry orchards, Ron quickly put two and two together. By going door-to-door and selling the cherries, he earned more than enough money to purchase the toy on the very first day. People that know Ron will often joke that he was born to succeed because he had a tremendous work ethic. But this story is more than just a cute anecdote from his childhood. It’s a lesson in the value of a hard day’s work. Ron embarked on a career in real estate at the age of 21. After four years in the industry, he opened up his own real estate firm. Ron grew his company to 95 agents and two offices before realizing that working with clients is what he enjoyed the most. Now, 30 years after his first business venture (selling cherries), Ron states, "I am finally doing what I was meant to do... Helping local families to realize their real estate dreams.

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