If you’re looking at homes above a $500,000 sales price and your time horizon (for financial planning’s sake) is 10 years or less, I would give you two options to consider.
One of which is the 5/5 arm starting at 3.25%, the other a traditional 30 year fixed at 4.25%. The 30 fixed is your safe bet and the 3.250% carries some risk, because the rate and payment can adjust higher after 5 years. Needless to say, this scares a lot of people away.
However, here is the difference and the reason I am writing this: until recently, the shiny 3.25% arm loan could potentially adjust upward to 5.25% on the 5th year anniversary and up again to 7.250% after year 6. Understandably, this scares many borrowers away.
The 5/5 loan has different rules when it comes to the adjustments, protecting the homeowner. On a 10 year time horizon, in every possible scenario, the 3.25% loan comes out ahead or worst case, a tie.
Introducing the 5/5 Arm…..a new loan product that carries much less risk than the 5/1 arm.
1. The 5 year arm only adjusts once, on the 5 year anniversary of the loan, and then not again for another 5 years.
2. The 1st adjustment would be no higher than 2%, meaning that the highest it could be is 5.25% for years 5-10.
This means that when comparing the original 3.25% and the 4.250% on a 10 year horizon, it is impossible for the 30 year fixed to win, when comparing total effective interest rate and total cost of the loan. If you hold the loan for 10 years, and the rates adjust upward on a worst case scenario, you would pay the same effective interest rate, averaged over the 10 years, as you would the 30 fixed.
What about after the 10 years? For people that plan to hold the mortgage longer than 10 years (say a baby boomer looking to retire in the home and pay it down to zero) they will likely choose the 30 fixed, however, the statistics show that most people do not hold the mortgage for 10 years. They are likely to either refinance or sell the home before the 10 year mark.
Making prudent financial decisions can often require a practical look into the future and holding assumptions that are grounded in reality. This is a clear example where a person who cannot make a strong case that they will hold this mortgage for the long term, may benefit substantially by going with the 5/5 arm.
Arm Loans background: 2004-2014
Given what has transpired in the industry over the past 8 years, there is a stigma that hangs over adjustable rate mortgage products. And for good reason, a lot of people were put into these mortgage without understanding the risks and got burned. However, most of these unfortunate scenarios were in shorter period arms from subprime products, which were all 2 or 3 years fixed and then adjusting up sharply after that. I remember because I worked for Countrywide Home Loans at the time, who did a great many of these types of loan.
I personally only did 2 of these subprime loans and I am confident the clients new exactly what they were getting into.
On the other hand, I can point to many of my clients who I put into arm programs, which have saved many thousands of dollars as a result. One of which is my father. I got him into a 3/1 arm in the fall of 2007, because the fixed rate at the time was more than 1% higher and I knew I could keep a close on it for him and refinance him out of it before the rate increased. A service I offer all of my client. As it turned out, we never needed to refinance it because the rate and payment kept moving down. Since 2010 he has seen his rate go from 6.3% to the 2.75% he is paying now.
About the Author ~ Since 2003, Beau has been a mortgage professional and is a leading best broker in San Diego. As Founder and Senior Mortgage Advisor at Transparent Mortgage he is truly committed to serving the needs of his clients and raising the industry standards for integrity and transparency.
Questions, Comments, or Personalized Rate Quote? Contact Beau today: 619-888-3606 or firstname.lastname@example.org