Rates are Rising, Time to Consider an ARM?

With mortgage rates finally looking like they are going to move upward a noticeable level in 2018 and forward, especially higher than what low levels have been in place to date, the return of the adjustable rate mortgage starts to come into play again. Better known as the ARM home loan, the adjustable rate mortgage can be a flexible, powerful tool, depending on how it is used.

When rates were much higher years ago, the ARM was an alternative way to obtain financing for a home without paying as much in interest with every payment. This was ideal for folks who felt that a few years forward the regular market rates would drop or they didn't plan to stay in the same home for thirty years. By trading away the mundane predictability of a 30-year fixed loan, the borrower was rewarded with a lower cost loan via an ARM. However, after a short period, anywhere from six month to ten years, the ARM would reset and the rate charged would change to a specific market index. ARMs became all the rage in the early and mid-2000s as people bought homes to then sell them quickly with rising property values. It was low cost interest paid for large sums of financing, which was then paid back and profits were made just holding a home two years or so and well within the typical ARM period. However, when the real estate market went south in 2009, many had to hold onto homes longer and rates reset to a higher, floating rate index.

Today, the advantage of the ARM again presents itself as rates begin to rise, offering again lower interest rates for home financing for a typical one to ten years. But these tools still include the rate reset after the intro period to consider, and with mortgage rates on an upward trajectory for the next few years it's almost a given the loan will cost more when the switch happens. Thus a borrower always needs to remember to play the ARM as a short-term borrowing tool by 1) sell the home prior to the reset date, 2) sell the home for a substantial amount more than it was bought for to recoup losses in sale gains, or 3) refinance to a fixed loan at a later date to avoid higher index floating rates.

The same caveat from a decade ago applies to today's ARMs: they can be extremely valuable for up-front borrowing savings, but borrowers need to always remain aware of the included reset date and what it means for further financial obligations down the line.