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ARM loans have risk for the uninformed

Are Adjustable Rate Mortgages Risky?

Adjustable rate mortgages, or ARM loans, are often blamed for the “toxic mortgage” time bomb that went off in late 2007.

The truth is, an adjustable rate mortgage is a great option for folks with certain goals.

Let’s start by talking about the biggest risk commonly brought up around the conversation about an ARM loan.

Predicting the Market

Most ARM loans in today’s market have a fixed rate and payment period of 5,7 or 10 years.  The scary thing is, what happens after that?

That’s basically the fear, right?  What if my rate and payment goes up? That’s a really valid question.

The answer is, it depends on your personal goals and your tolerance for risk.  Nobody can predict what the market will look like in the future, so there is some chance there.

Your tolerance for risk will be tested knowing what you’ll have to make some financial decisions about your home mortgage following the fixed start rate period.

Right Place at the Right Time

In today’s economy, interest rates on adjustable rate mortgages can be as low as half that of a 30 year fixed loan.

This makes adjustable rate mortgages awful enticing.  There are two questions you have to ask yourself before considering an ARM loan:

How Long Will You Stay in the Home?

If this is a starter home, or if your family is growing, or if you can be relocated for your job at almost anytime?  The general rule of thumb I use is if you are almost positive you will be in the home for less than 10 years, an ARM is a great option to consider.

Let’s take a look at a quick hypothetical loan scenario using realistic numbers:

5/1 ARM – 2.875% (based on FHA rates as of September 1st, 2011)

We are now 5 years in the future – the 2.875% fixed rate and payment period is up, our first adjustment is coming up.

This 5/1 FHA ARM is tied to the 1 Year Libor, which is currently at .802%, with a margin of 2.25%.

If the rate adjusts today, you are looking at about 3.125%, or a .25% increase in rate.

You’re now 6 years into your home loan, paying an average interest rate of under 3% for the money – I would say that’s a pretty good scenario!

Is an ARM too Risky?

No, I don’t think so.  I think not knowing all of your options, both the benefits and risks, is risky.

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If you have questions about using an adjustable rate mortgage, or if you already have an adjustable rate mortgage and you want to make sure you know what will happen when it adjusts, feel free to start a live chat, give us a call or leave a comment below.  Hope this is helpful.

About the Author

Scott Schang

A 20+ year veteran of the Mortgage and Real Estate industry, I am passionate about educating and empowering consumers. I have been writing about consumer protection issues and making sense of complicated real estate and mortgage topics on this website since 2007

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