A Fixed Rate May Not Be The Best Option


Look back to 2004 when the Federal Reserve Chairman, Alan Greenspan, famously stated that Americans may be paying too much on their monthly home mortgage by taking a fixed rate option.  His recommendation, at that time, was to look for adjustable rate mortgages that may make more sense given the individual situation.  Well, one thing led to another and we know what happened with adjustable rate mortgages (ARMs).  Lenders began offering short term 2 & 3 year ARMS on almost every program and for almost every borrower.  Once these loans adjusted higher, the ARM market became the scapegoat for the mortgage crisis.  Almost ten years later, savvy buyers are only now starting to give ARMS a second chance.

Adjustable rate mortgages aren’t for every buyer.  You must have a clear plan for your property before you even entertain the idea.  Most of the 2 & 3 year ARMS are gone, but the 5 and 10 year plans still remain.  In some cases, the change in rate could be a point or more from the ARM rate to the 30 year fixed rate.  Depending on the size of the loan, this could mean a difference of hundreds of dollars every month.

If you are considering an ARM, you should know how it works.  The ARM is still amortized over a 30 year period, but only fixed for the designated ARM period of 2, 3, 5 or 10 years.  After that, it will adjust usually every six months or so based on the index that it is attached to.  Borrowers who currently have ARMs have actually seen a reduction in rate since the market has moved that way.  Those who had ARMs in 2009 saw a sharp increase that they could not afford and contributed to the mortgage crisis.

The most important factor to look at if you are thinking about an ARM is the difference between the fixed rate and the adjustable one.  It is very difficult to predict what you will want to do in five years and where the market will be.  If the difference between the fixed and adjustable is not sizable, it would make sense to go with the security of the fixed and know that your payment will not change for the next 360 months.  If the spread is a few hundred dollars a month, you need to consider your five and ten year plans for the property and think about what you would do with the monthly savings.

It is easy to assume that the market will turn in five years and you will be able to refinance into a fixed rate after the adjustment is over.  That is what happened back in 2009 and it wiped out many investors.  Always assume no appreciation and think about what you would do if you had to keep the mortgage after the adjustment period.  If the property is a long term hold and you need the monthly savings from the ARM, you should consider the 30 year fixed option and not take any chances.

An adjustable rate mortgage should not be looked at as evil or quickly dismissed if you are buying.  In the right situation and the right loan amount, an ARM may be your best option.  Discuss your plans for the property with your lender or mortgage broker and get all of the mortgage options available before you decide to do anything.