ARMs Offer Mortgage Flexibility with Risk

Nationwide is an experienced California mortgage broker offering insightful advice for refinancing ARM's with second mortgages and fixed rate loans. Where there is flexibility and low interest rates there is probably some inherent risk as well.

A few years ago adjustable rate mortgages were very popular because the interest rates were several percentage points less, and homeowners were able to save hundreds of dollars a month in most cases.

Interest rates don't really need to be high to make an adjustable-rate mortgage (ARM) attractive. All you need is a good idea of how long it will be until you sell your house. In order to understand why this is important, you have to remember that there are three elements to every loan:

1. the amount you borrow;
2. the interest you pay, and
3. the length of the loan. The longer the term of the loan, the higher the interest rate will be. Conversely, the shorter the term, the lower the interest rate will be.

With an ARM you have a fixed interest rate for a set period of time, from one year on up, explains Doug Winter, area manager for Wells Fargo Home Mortgage in Minneapolis. That fixed rate is guaranteed for an initial period, say one, three or five years. After that, the rate goes up or down. An ARM is based on thirty years, so the rate can fluctuate over the life of the loan. While the 30-year mortgage was once the standard approach to home buying, this is no longer the case. Winter says, "The whole philosophy of consumers buying homes has changed. It used to be that many people planned to stay in their home for 30 years, and their objective was to pay off the mortgage to actually own their own home."

Today, however, more and more people see their home as both an investment and an asset. "People realize they will probably never pay off their mortgage," Winter says. "They are using it as a financial asset and looking for the best way to maximize their payments. They know that their financial responsibilities and situations will change over the years. They know they will need to refinance, move up, or move down. "In addition, we are finding buyers who are being relocated and have a high possibility of being relocated again. They don't need a 30-year mortgage, so they try to maximize their investment. I think the buyer today sees this huge asset sitting there, and he or she is going to use it. If you know you will be moving in five years, why would you get a 30-year mortgage?"

Today, Winter adds, the typical loan lasts less than seven years. "So even when 30-year interest rates are low, adjustable rate mortgages are still a major part of our loan production because the ARM rate is lower. There are also many different types of ARMs." There are government-backed FHA (Federal Housing Administration) adjustable rate mortgages, which are only available in one-year increments, or VA (Department of Veterans' Affairs) ARM loans. VA Arms are now available in one-year, three-year, five-year, seven-year and 10-year increments, much the same as conventional mortgage loans (those not guaranteed by a government agency). How much difference is there between ARM and fixed rates? Winter says that if the 30-year-rate today is 5.625 percent, you could expect to pay 4.625 % for a one-year VA or FHA ARM. A conventional one-year ARM would probably be around 3.75 percent. You would probably pay 3.875 % for a three-year loan, 4.5% for a five, 5.125 % for a seven, and 5.5 % for a 10-year loan.