While the number of home buyers using adjustable rate mortgages (ARMs) has increased to 35% from 14% a year ago, according to the latest figures from the Mortgage Bankers Association, there are still many people who don’t understand ARMs. While it’s true that these mortgages are not for everybody, they are an attractive mortgage-financing alternative for many.
In an effort to help you explain to your clients what ARMs are all about, the following outlines the 10 most common misperceptions or myths about ARMs, and their realities.
Myth #1: ARMs are not appropriate for the average borrower
REALITY: When you consider that the average life of a mortgage is currently six years, ARMs are often more appropriate for the average borrower than 30-year fixed-rate loans. In today’s market, and in most markets over time, ARM loans carry a lower interest rate than 30-year fixed-rate loans. So if you are not planning on living in the same house for the next 10 years, paying the higher cost for a 30-year fixed-rate mortgage is like throwing money down the drain. For example, homeowners who know they will be refinancing or selling their home within five years would save thousands of dollars by electing a 5/1 ARM, in which the interest rate is fixed for the first five years and then adjusts annually, versus a 30-year fixed-rate loan.
The payment savings can be used to pay off the house faster, increase personal savings, or allow people to buy “more” home.
Myth #2: ARMs expose the borrower to payment shock
REALITY: Traditional ARMs adjust on a monthly, semi-annual, or annual basis. So in a rising-interest-rate environment, a borrower with an ARM can expect his or her mortgage rate and mortgage payment to rise. But when mortgage rates drop, so will the borrower’s payment. Moreover, there are alternatives to short-term traditional ARMs, including a whole class of mortgage loans called hybrid ARMs, which have fixed interest rate periods from three to 10 years.
For borrowers who know they’re going to be selling their home or refinancing within a set time frame, the hybrid ARM can be a wonderful alternative to a higher cost 30-year or 15-year fixed-rate mortgage.
Myth #3:ARMs are not a good choice in a rising-interest-rate environment
REALITY: ARM products are very different than they used to be. Today, many ARM products offer significant fixed-payment periods. As Federal Reserve Board Chairman Alan Greenspan famously remarked this spring, “Homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages (ARMs) rather than fixed-rate mortgages during the past decade.”
Although ARM rates can increase, they also can decrease. If the borrower knows he or she will need to refinance the mortgage or sell the property some time in the future, an ARM is an economical alternative to a 30-year fixed- rate mortgage. For example, a 1.5% difference between a 30-year fixed-rate mortgage of $500,000 and a 5/1 ARM can save the borrower $37,500 in interest over a five-year period.
Myth #4:ARMs are more expensive than fixed-rate loans in the long run
REALITY: Generally, it is not true that ARMs are more expensive. The longer the term of the borrowing, the higher the interest rate. An ARM could be more expensive if you had a one-month, six-month, or one-year repricing ARM and interest rates did nothing but climb. However, interest rates move up and down, and as they do, a borrower’s loan rate moves in the same direction. When you consider that the average life of a mortgage loan in the United States is only six years, it may not make sense for the average borrower to elect a 30-year fixed-rate loan.
Myth #5:ARMs are for borrowers with too little income to qualify for fixed-rate mortgages