During the Subprime years and prior to the mortgage meltdown; Adjustable Rate loans were taking the day. Not often have I ever recommended an Adjustable Rate Mortgage over a fixed rate loan. If the client wanted the product and they were knowledgeable about it, and they understood that the interest was going to adjust from the initial rate; I had no choice but to give them their wishes. That said, with a fixed rate of payment; there are no surprises should your income change. With the current economy, neither job security, nor salary is a guarantee in far too many instances; therefore having set payments for the life of the loan is helpful in keeping your credit and financial status in line.
The above reflections do not mean that it is always a bad product, and there are times it can be beneficial, but for the average client it may not be. Some recommend ARM loans for the person who is not in an income grade where they see significant increases in salary and who intend to stay in the home for a long period of time. The ARM product is needed so that their debt to income ratios fall in line with guidelines. This is not always in the best interest of the mortgage applicant. The ARM loan should be used with great care and with an extremely large amount of explanation. It is also the applicant’s responsibility to be well informed and to ask questions until they are totally comfortable.
The interest rate; simply put will not stay the same for the life of the loan. It is always best to understand why ARM loans fluctuate. In the past before the mortgage crisis; applicants received ARM loans with interest rates in the 3% range, but guess what? These loans rate of interest changed every 6 months, sometimes after the first six months and sometimes after the first year, depending upon the type ARM product it was. They did not understand or have a clue that this ARM they received would fluctuate every six months. It is always the Loan Officer’s responsibility to inform their clients. Some of these were called the Libor ARM and some were called the Option Arm. The client’s income did not rise, but the ARM rate and payments did.
All mortgage applicants should make sure they know exactly what type ARM they are getting, when it will change the first and then thereafter. You should get an ARM disclosure which is required by RESPA. The ARM disclosure should be sent to you initially before closing.
ARM loans (12 month adjustments) can be helpful for someone who is transferred with their employer on a regular basis, every 3 to 5 to 10 year period; therefore you have the convenience of the lower rate until you pay off the loan when you sell you home. ARM loans always adjust from that initial rate and if the market changed drastically, the payment changes could drastically lead you to default. Normally the adjustments for each period have caps so that they cannot rise above one to two percent, depending again on the product. These adjustments/rate caps will be listed in the ARM disclosure which explains your Adjustable Rate Loan.
FHA’s (Federal Housing Administration) 1 & 3 year hybrid ARM loans have an adjustment of 1% after the first change date and a 5% life of loan cap. The 5, 7, & 10 year hybrid ARM has a 2% initial rate adjustment, after the first change date, with a 6% life of loan cap.
FNMA (Fannie Mae) ARM Products are 1 yr adjustable, 3, 5, 7 & 10 year adjustable loans. These ARM loans are with 1% to 2% after the initial adjustment period and life caps from 5 to 6%. The 7 year (fixed for 7 years) & 10 year (fixed for 10 years) ARM loan can have a start rate increase up to 5%. The latter 5% would really make a big difference in your payment!!!! This is not a product for the first time homebuyer, unless they are in a profession that is going to render pay increases consistently. Each situation is different, therefore this might be a product you could afford; but only you should make that decision after a lot of thought.
There are reasons why people choose ARM loans. Lower payment initially, will not stay in the house very long, or they are expecting a raise within the near future. The initial lower rate of interest and payment may be essential in some cases to allow a borrower to qualify for the loan; which they might not be able to obtain otherwise.
It is always best to seek explanations for any mortgage loan product. The more questions you ask the less likely you will receive a loan that you cannot pay in the future. It doesn’t matter if it is a fixed rate loan or an Adjustable Rate Loans (ARMs); questions are never out of line when putting your name on the dotted line for 20, 30 years.