By Elizabeth Lucchesi
Notoriously given a bad rap for purported uncontrolled rate rises and balloon payments, the adjustable-rate mortgage is a lending tool currently being called on by more and more buyers and their lending partners.
With careful consideration and the support of a professional lender, an ARM can make purchasing a home more attainable, especially for first-time buyers.
The last several years have offered idyllic interest rates, with historical lows close to borrowing money for free.
Most recently, fixed rates have been soaring, with the average 30-year hitting 5.25% last week, according to Freddie Mac – nearly a 2% increase since the beginning of 2022. Combine interest rate hikes with increasing home prices and record low inventory, and you’ve got buyers desperate for an avenue to homeownership.
Enter the adjustable-rate mortgages – or ARMs. An ARM can make home buying more affordable for buyers during the beginning of their loan term. A 1% rate reduction can reduce monthly mortgage payments by several hundred dollars or more during the initial loan term.
When the initial loan term is complete, the variable interest rate is determined using a fixed benchmark – such as the Fed Funds Rate, the prime rate or the LIBOR, among others – plus the margin, a set amount of interest above the index rate. The index is variable, while the margin is constant.
ARMs generally have caps limiting interest rate increases per year or over the loan’s lifetime.
The most common type of ARM is the hybrid, and it offers a combination of fixed and adjustable-rate periods. Usually, these loans are named using the fixed interest rate term length combined with how often the interest rate is subject to adjustment after the initial loan term. For example, in a 10y/6m ARM, the 10y represents a fixed interest rate for the initial 10-year period, while 6m means the interest rate is subject to adjustment every six months for the loan’s lifetime or until the buyer refinances.
With careful consideration and the support of a real estate professional and trusted lender, an ARM could be a smart choice for your home buying needs. Talk with your team to decide the right approach.
The writer is the founder of the LizLuke team at Long & Foster Real Estate. She is also a buyer and seller agent.