An Adjustable Rate Mortgage is a perfect solution for borrowers who are interested in saving money with a lower interest rate. In the past, the adjustable rate mortgage was the topic of many articles. Those articles pointed out the negatives, but overlooked the positives. Proper up-front analysis is the key. Some borrowers bought houses they couldn’t afford using exploding ARMs—a 2 percent teaser rate could jump to 8 percent within two years, even if market interest rates didn’t change. Today ARMs are only a small part of the market, but here’s the surprise: Most don’t adjust for five, seven or ten years and can make sense for homeowners with lots of equity if they plan to downsize or pay off the loan within that time frame.

Given that 15- and 30-year fixed mortgage rates are at a historic low, should you even consider an ARM? Our feeling is that if you’re aiming to pay off your mortgage in a short period of time you may be able to save some cash. Real savings happens if you pay off the loan within the five to seven years before the ARM adjusts—effectively turning it into a very short, very low-rate fixed mortgage (which is great, if you plan to move in the next several years or if you want to pay off a big mortgage before you retire).

How Do They Work?

On a 5/1 ARM for loans up to $750,000, at 2.75 percent, with a 2/2/6 cap. The 5/1 part means the rate is fixed for five years and adjusts up or down annually afterward (based in this case on the Libor index). The 2/2/6 part means the maximum first-year adjustment is two percentage points above the initial 2.75-percent rate and after that it can adjust another two percentage points each year, with a maximum lifetime adjustment of six percentages points—so it can hit 8.75 percent in year eight and beyond.

Don’t Go Too Short!

If you’re selecting an ARM because you expect to pay off the mortgage before the initial rate period is over, leave yourself extra room. For example, if you expect to sell in six years, take a 7/1 ARM rather than a 5/1 ARM.

Stick to Your Early Payment Schedule

If you’re aiming to pay down a 30-year ARM quickly, make sure there are no prepayment penalties. Then calculate how much extra in principal you’ll need to pay a month. (If you don’t stick to the schedule, check into refinancing again.)

Don’t Go Too Big

With rates so low, it’s tempting to refinance for more than your existing principal and use the extra cash to, say, build a dream gourmet kitchen. Just don’t stretch too much when taking an ARM. You’re still assuming interest rate risk—even if it’s put off for five or seven years.

Questions to Ask Yourself

Question 1: Are you interested in saving money?

Interest rates on ARM products are still near 4 percent. The benefits of historically low rates are still an option. You may have missed out on the lowest 30-year fixed rates we’ve seen in a while, but you still have an opportunity.

Question 2: Did you ever pay off a 30-year mortgage loan in your lifetime?

Chances are no. Most people move or have a life-changing circumstance that compels them to adjust their current mortgage well before 30 years. Some facts to think of:

• Americans live in three- to five-year increments typically. Most people refinance every five to seven years on average anyhow.
• ARMS are amazing for clients with short-term plans of staying in their current residence.
• ARMs are a fantastic way to increase equity or be in a position to drop PMI payments sooner.
• ARMs allow clients to manage their home as an asset versus a liability.

Question 3: What are your financial goals for the next three to five years?

Was there a recent marriage, or a divorce? Is there an addition to the family? Are there debts that need to be paid? New roof? Would lengthening your term save more money? Plan to sell soon?

Life is a big roller coaster ride, so remember ARMS are flexible and can adjust with your life.

By Carl Guzman

 Carl Guzman, NMLS# 65291, CPA, is the founder and President of Greenback Capital Mortgage Corp. He is a residential financing expert and a deal maker with over 25 years’ experience. Carl and his team will help you get the best mortgage financing for your situation and his advice will save you thousands! www.greenbackcapital.com [email protected].