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Is It Time To Refinance?

Since the “Financial Crises”, the “Mortgage Melt Down”, the “Great Recession” Adjustable Rate Mortgages (aka ARM’s) are just not what they used to be. The ARM was one of the culprits of the Financial Crises. It was a very popular financing option in the early 2000’s as it had a much lower rate that resulted in artificially low payments on homes. Eventually they all had to adjust and they did, UP!

This caused many home owners to go into default as they could not make their new monthly payment and they had little to no equity in their homes so they could not refinance or sell and get out of the ARM they where in. Enough, with the history lesson. Should you use ARM financing when buying a home?

It depends.

Are you using it as a financial tool to save you money?

Yes, then an ARM might be right for you. Here is what you need to consider.

ARM’s have initial adjustment periods and can go up as much as 5% in the first adjustment period. The ARM options today are 5/1, 7/1, and 10/1. The first number being the number of years the rate is fixed and the second number how many times per year after the initial adjustment period the arm can adjust. We will be using the 5/1 ARM for now.

For the first five years it is fixed at the rate you closed your loan at. On the 61st month of your loan your rate is going to adjust. It will most likely go up. ARM’s have caps, limits to how much they can adjust. Most 5/1 ARM caps are 5/2/5. The first 5 is the cap on the 61st month. Your rate can not go up by more than 5% the first adjustment. Example, you closed at 4% on month 61 your rate can not exceed 9%. The second number, 2, is the max the rate can go up every year after that and the last number, 5, is the maximum that it can adjust over the life of the loan.

Confusing, I know and it is why you should only use an ARM as a tool to save money and not to try to qualify for more home. That is exactly what happened in the early 2000’s and many home owners suffered because of it.

There are other qualify features that have been put in place today on ARM’s. Using the 5/1 ARM with 5/2/5 caps with an initial rate of 4%, you would have to qualify for the mortgage at 9% also known as the fully indexed rate. This was done to make sure you, the home owner, can afford the higher payment if you do not sell before the first adjustment period.

ARMs just don’t save you the money they once did. Since they where a major part of the financial crisis, Banks and Mortgage Companies do not like them today. They are considered high risk and carry a higher premium than they used too. What does that mean? Let’s say a 30-year fixed today is at 5.25%,  a 5/1 ARM would be 4.875%. Not much savings! Additionally, the closing costs on that ARM are going to be higher.

Now if you really shop you may be able to find an ARM that is half a percent or lower than the going 30-year rates. The question still stands, should you go for the ARM? 

The Bottom Line

Only if you know with-out a doubt that you will be SELLING you home before the first adjustment period! I highlight SELLING for a reason.

Mortgage Loan Officers are going to try to convince you that you can just refinance before the ARM adjusts. Five years is a long time. Rates will go up and down, home values in your neighborhood will go up and down. Your household income will go up and down. Your credit score will go up and down. Basically, everything that is allowing you to qualify for the ARM today will change in 5 years. There is no one that can guarantee you that you can REFINANCE out of your ARM mortgage.

Bottom line, only consider an ARM if you know that you will be selling your home before the first adjustment period and you have a hefty down payment or equity in your home today!