After the housing market crash a few years back, adjustable rate mortgages were attributed to thousands of people being unable to afford their monthly payments, thereby leading to an unprecedented number of foreclosures. In the months following the housing bust, adjustable rate mortgages were increasingly shied away from, as consumers were leery of falling victim to sudden rate increases. While they may have died down in popularity, some financial experts claim they are nonetheless making a comeback.
Is this a good thing? The answer depends on who you ask. Lenders who are offering the newer adjustable rate mortgages claim that things are different this time around. They say that the initial rate is much lower than a conventional fixed-rate 30-year mortgage-in fact; many have rates that are at their lowest in more than a decade. The fact that initial rates are much lower on ARMs is nothing new, as this was also the case prior to 2008. This time, however, banks claim they are no longer targeting subprime borrowers with these low rates. Instead, they are being offered to those with good credit who are primarily taking out “jumbo” mortgages, which are loans that are higher in amount than what conventional loan limits allow for.
In fact, some of the higher-dollar mortgages across the country are increasingly being financed by adjustable rate mortgages. Black Knight Financial Services recently compiled data that showed 31% of all mortgages in the $417,000 to $1 million range were ARMs. Among mortgages that were more than $1 million, 61% of them were ARMs as compared with 56% just one year earlier.
Reasons for Renewed Interest In ARMS
The fact that interest rates have risen somewhat has led to more and more people wanting to consider adjustable rate mortgages again. This is especially true when it comes to jumbo loans, because the larger the loan amount is, the more money people can save up front.
Another reason why many borrowers are considering them again is because home sales across the country are on the rise. As a result, a number of people are taking out these initially low-rate loans, while simultaneously planning to sell their homes in only a few short years, thereby beating any future increases.
Who Benefits From An Adjustable Rate Mortgage?
Consumers who are fairly certain how long they may stay in their home have the best odds of benefiting from an adjustable rate mortgage. Those who are planning to sell their home in only a few years are also in a better position to choose the ARM that best suits their needs. Adjustable rate mortgages have an initial fixed-rate period of three, five, seven or 10 years, and the lower the initial interest rate is, the shorter the fixed rate period normally is.
Those who plan to stay in their home for longer periods may save money initially; however, those savings could easily be negated over time. Mortgage interest rates are unpredictable, so spiraling rates at the end of the fixed-rate period could spell disaster for those who are already struggling to meet their monthly expenses.
As a result, buyers who are considering an adjustable mortgage should carefully consider:
- Buying far less home than what they can afford
- Making additional payments on the principle during the fixed-rate term in order to reduce the amount they owe
- Have a plan for increasing their income or reducing expenses significantly at the end of the introductory period
- Preparing to refinance to a lower rate before the initial term expires
Natural Part of Recovery Cycle
Some financial analysts claim that a return to adjustable rate mortgages is a natural part of the housing market recovery cycle. With growth beginning to stagnate, financial institutions are now looking for ways to loosen their lending standards somewhat without taking too great of a risk. One way of doing that is by touting adjustable rate mortgages as an affordable alternative to a conventional mortgage.
By restricting who is eligible to obtain them, many believe a viable compromise has been made. Adjustable rate mortgages can help spur recovery in the real estate market, so long as lenders and borrowers both use caution when choosing them. With new lending restrictions now in place across the board, many are hopeful that will indeed be the case.
This guest post was written by Chad Dannecker, team leader of Dannecker & Associates. With more than 40 years of local real estate experience, Dannecker & Associates has established themselves as the leading source for condos in San Diego.
