Vail Daily column: Leverage mortgage debt while you still can
Adjustable rate mortgages — ARMs, hybrid loans — however or whatever you want to call them, are loans that do not have a fixed rate for their amortization full term and are starting to come back into the market. With good reason, I might add.
By an adjustable rate mortgage, I am referring to loans that have a fixed rate for a certain period or portion of the loans’ entire term. After this pre-determined period of time has elapsed, the loan will begin to adjust for the remainder of the term. In most instances, the loan will adjust one time per year based upon a current market index (such as the LIBOR Index or U.S. Treasury Index) added to a margin or markup from the lender.
For example, a 5/1 LIBOR ARM with an initial rate of 2.75 percent and a 30-year amortization means that the initial rate of 2.75 percent is fixed for five years. If the loan is held or kept by the borrower from years six through 30, then the rate will adjust one time per year. In most cases, the loan will be paid off in full after the 30-year term. During the early 2000s, adjustable rate mortgages seemed to be the preferred loan of choice from savvy and experienced real estate investors to first-time homebuyers.
Then the subprime mortgage meltdown in 2008 occurred and everything changed. Financial institutions that were a mainstay on Wall Street went bankrupt. Stock markets tumbled. Adjustable rate mortgages were deemed the root of the demise to one degree or another.
Since the financial meltdown in 2008, the mortgage industry has undergone monumental changes and corrections. There have been changes, improvements, regulations and lessons learned since this time. During this time, ARMs were more or less not a viable lending product or option. Slowly and surely, adjustable rate mortgages are starting to become more common in the market place.
Qualification criteria for adjustable rate mortgages is now stricter and more scrutinized than it was in the early 2000s for starters, making these loans much more financially secure. The rate in which the borrower must qualify for the loan if often based off of a worst or highest case scenario and more reserves or money in the bank are required for qualification than with a fixed rate loan. More down payment or equity may be required from the borrower depending on the variables of the loan as whole.
For the right set of circumstances and the right borrowers, ARMs are still an advisable and savvy financing option. For starters, an adjustable rate mortgage is going to have an interest rate of nearly 1 full percentage point less than a loan with a fixed rate term such as a 30-year fixed rate mortgage. This is a general but applicable statement between hybrid loans and fixed rate loans.
One full percentage point less on the interest rate can often mean hundreds of dollars less per month on the principal and interest payment. I doubt any of us would have trouble determining what to do with an extra few hundred dollars per month. Paying down debt or padding 401k retirement accounts are two uses that spring to mind.
Borrowers or buyers with shorter term plans for the home are really an advisable candidate for an ARM. A buyer’s plan for the home is a case-by-case scenario and dependent upon many variables. Nonetheless, those who do not plan to be in a home more than a few years, or even those who plan on paying down the loan’s balance at a rapid rate may in fact be better suited for an adjustable rate mortgage.
In an environment of potentially rising interest rates, adjustable rate mortgages do tend to get more consideration. Being lured into an ARM for the monthly savings aspect is one of many variables that need to be considered. But if properly analyzed and fully understood, an adjustable rate mortgage can be a savvy financial instrument. Guidance from a seasoned loan officer is required in making such a decision as the product itself is complex and many factors need consideration.
William A. DesPortes works for Central Rockies Mortgage Corp. He can be reached at 970-845-7000, ext. 103, and email@example.com.