Pros and Cons of Adjustable-rate Mortgages
By Lisa Scontras
The recent uptick in mortgage interest rates has spurred the return of the adjustable-rate mortgage or ARM. Though mortgage rates remain low by historic standards, the resurgence begs the question: When is an adjustable-rate mortgage better than a stable, but more costly, 30-year fixed-rate mortgage?
According to Jeffrey Bamer, Vice President of the Investor Management Department at First Hawaiian Bank, borrowers who expect to stay in their home for 10 to 15 or more years, and also tend to make the minimum monthly payment, may be better off with a fixed-rate 30-year loan.
“Or if you may not be able to afford your monthly payment if rates go up, you should avoid the temptation of the lower initial rate,” he adds.
Bamer points out, the three most common reasons borrowers will not keep a loan for 30 years are: 1. They move, 2. They refinance to take out equity, or 3. They refinance because rates drop.
Basically, the appeal of an ARM is the extra low introductory rate. But the trade-off with obtaining these low rates is the risk that your payments may increase if rates rise.
“There are more terms and variables in an ARM loan, so borrowers should ask lots of questions and be sure to fully understand the loan product they are choosing,” says Bamer.
However Bamer does believe there are circumstances that make opting for an ARM smart, and in fact, has recommended one of First Hawaiian Bank’s new products — a 10/1 ARM — to some of his friends. The 10/1 ARM combines the advantages of an ARM with a fixed-rate loan into one product. The interest rate stays fixed for 10 years, and still offers a rate significantly lower than most fixed-rate loans.
“This is a great way to use the savings and pay down your loan faster,” says Bamer. “Also, sometimes the cost is lower with less points.”
The topic is a hot one, so Bamer addresses some of the most common questions:
What circumstances would make opting for an ARM appealing, even smart? “ARMs are ideal for customers who don’t plan on being in their home for the very long term. Couples buying a starter home, for example, who plan to move up to a larger home in a few years, or those borrowers who can reasonably expect their income to rise by the time the rate adjusts.”
What are the pros associated with an ARM? “The low initial rate can save people thousands of dollars in interest. And because lenders can use the lower introductory rate to qualify borrowers, people can buy a larger home than they otherwise could have. Also, if rates fall, borrowers on ARM loans will get the advantage of having their rates go down without having to go through the refinancing process.”
What are the cons? “The downside to an ARM loan is, of course, the uncertainty. You don’t know exactly what your payments might be once the ARM adjusts.”
Aren’t ARMs what got so many people got into trouble during the housing crisis? How are today’s ARMs different? “The loan feature that caused the most problems was negative amortization, which meant that the balance a borrower owed on their home could actually go up each month. First Hawaiian Bank has never offered negative amortization on our mortgage loans because we recognize the potential danger to our customers. We also want to make sure that borrowers can afford their payments even if their rate increases.”
Are there limits to how high my rate can go? “Yes. There are caps for how much your rate can change per year, and also caps to how high it can rise over your start rate. For our 10/1 ARM, for example, the annual cap is 2 percent, and the lifetime cap is 5 percent over your initial rate. So if your initial rate is 3.5 percent, it could change by up to 2 percent each year starting around 2025, and could go no higher than 8.5 percent.
What would you say is most misunderstood about ARMS? “Most people think the rate on ARMs changes every year starting immediately. But there are hybrid ARM products that begin with a rate that is fixed for 3, 5, or as long as 10 years before the rate ever adjusts. And the rates on these products are still significantly lower than longer-term fixed rate loans. These can give you comfort in knowing your payment won’t change during that initial period. And borrowers can choose the term that is right for their situation and future plans.”
What questions should a person ask who is trying to decide what type of loan to get? “How long do I plan on being in this home? If the answer is 7-10 years or less, then an ARM may be the smartest way to go. Also, can I afford my payments if the rates go up?”
The opinions, statements and views contained in this article are those of the author, and do not necessarily represent the views of First Hawaiian Bank or its management. First Hawaiian Bank does not warrant that the information herein is accurate, complete or current.