When times are tough, thinking outside the box is a good idea. In most cases, we all want a standard fixed-rate 30-Year mortgage.
I talked about new options in “40-Year Interest-Only Mortgage,” which proved a bad idea. But do we have more choices with interest rates crossing 7% on new mortgages?
Our old enemy is back, and it is worse than ever. Yes, welcome Adjustable Rate Mortgages to the stage, and hopefully, it exits stage left rather quickly.
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Why do Adjustable Rate Mortgages (ARMs) have such a bad name? Can they serve any homebuyers in today’s frosty homebuying climate? Let’s explore ARMs more in-depth.
What are ARMs? For an in-depth definition of adjustable rate mortgages, I will refer you to Rocket Mortgage. If you read the entire article, you can see just how complex ARMs can become over time.
An ARM is a mortgage with a fixed rate for a “teaser” period, usually 5, 7, or 10 years. After the initial fixed rate, the mortgage can then change interest rates every year.
Yes, that’s right. It doesn’t just adjust once; it can change once every six months or year. Can you imagine this type of madness?
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What a ride. If your introductory period ended in the summer of 2021, when rates were around 3%, you would be paying over 7% today.
No matter how sophisticated you are, having a mortgage double in interest in a year would be jarring. There is almost no way to get ahead financially in this sort of chaos.
However, buying a home in today’s environment is extremely challenging. Not only are interest rates high, but home prices are still in the clouds.
That means the average homebuyer will buy an expensive home with a high-interest rate. Most people cannot afford to buy in this market, so that they may turn to ARMs for assistance.
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Can an ARM work for you? I just checked today’s rates:
- Standard conventional mortgage: 5.75%
- VA Loans: 5.875%
- Adjustable Rate Mortgage (5/5): 5.125%
In this scenario, the ARM is not worth saving 0.625% from your interest rate. However, a conventional loan may require you to bring a 20% down payment to the table.
If these numbers lean more towards the ARM’s interest rate, you will have to do some serious due diligence and consideration.
Most people are not good at math, and the ARM is a lot of arithmetic. I was reading the article on Rocket Mortgage, and I even got lost.
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You can miss something relatively easily when dealing with hyper-complex math contracts, like reverse mortgages or annuities. Be careful when signing these contracts because your financial life is on the line.
Refinancing out of an ARM. The idea behind an ARM is to refinance out of it before the “teaser” rate expires. However, let’s review how the refinance process works.
To refinance a home, you must have significantly more home equity than your remaining mortgage loan amount.
The bank usually wants a minimum of 75% home value to mortgage. For example, if your home is worth $100,000, they want your remaining loan to be $75,000.
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The bank is not your friend; they want to ensure they can sell your property if you default. What do these numbers mean for an ARM refinance?
You’ll have to ensure you hit these refinance numbers if you have a seven-year teaser payment. Some years, the housing market will quickly push you beyond the equity you require.
In other years, your home value may grow little at all. In worse cases, your home value will go negative after you buy it. This happened to me between 2008 and 2015.
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Your life’s on the line. Do you truly want to be caught in this kind of situation? If you have enough money to buy the home outright after the “teaser,” you have it good.
But how many homebuyers are sitting on this much cash? An ARM can work against you in most cases. ARMS got a bad name in the 2002-2008 housing market boom.
The housing market was pushing home prices through the roof in a matter of a few months. People used ARMS to get into a home, then could easily cash out refinance in a year or two.
The days of fast and easy money are gone. We are entering a slowing recessionary economy and must be diligent with our resources.
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I do not see a case for using an ARM unless you are in a top-notch financial situation and understand the risks. In short, you must have an investor mindset and the assets to pull off this maneuver.
Where do you stand financially? If you are struggling, an ARM isn’t going to save you. Hope, or hopium, is not a strategy.
If you say things like “I’ll make more money in seven years” or “interest rates will fall drastically in seven years,” you are hoping for an outcome.
Are you willing to take your family for a ride that you do not know where it ends? Yes, you could sell the home in seven years, but where will you buy your next home?
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An ARM is far too risky for 97% of homebuyers. People with a huge pile of cash can use them to get into a home to rent to others. If ARM converts higher, they can sell or pay off the house.
Conclusion. There is a reason I write about finances every day; money is complex and takes an advanced financial education.
An ARM can be an asset if you are willing to do the legwork. You will have the resources to prevent disaster when rates reset.
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However, most people want to do something other than the required legwork of building a nest egg, looking at historical interest rates, and creating a backup plan.
They just want to buy a house today. If you are hoping for things to swing in your favor over seven years, please stay away from ARMS.
We can create our own luck through education and action. We can’t depend on random events to achieve our desired results, especially when we have $500,000 to $1 million in the balance.
I am not a fan of ARMS for the average person. Heck, I am staying as far away from ARMs as possible. I do not want the drama, nor should you. Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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