Should you consider an adjustable-rate mortgage?
September Buying Advice: Rising prices and rates are making these loans attractive, but are they for you?
It's getting harder for many first-time buyers to afford a home in many markets across the country. The average rate on a 30-year, fixed-rate mortgage has climbed 16% in the past year, at the same time that the median home price shot up 14%.
In the past couple of months, lenders say, buyers looking to lower their monthly payments have started inquiring about adjustable rate mortgages, those riskier mortgages often blamed for the housing bust.
"We are definitely seeing more interest in ARMs," says Malcolm Hollensteiner, director of retail lending for TD Bank.
Can they be trusted this time around? Who should consider these loans, which vary in rate after an initial fixed period? And who should stick with the standard 30-year fixed-rate loans?
In this September installment of Buying Advice, we'll school you on the pros and cons of today's adjustable-rate mortgages, check in with the latest housing statistics and help you understand origination fees when shopping for a mortgage. (Bing: What is an origination fee?)
Are you ready for an ARM?
Applications for adjustable-rate mortgages are starting to pick up again, as 30-year fixed rates have climbed nearly 0.8 points in the past year to an average of 4.75% in the week ending Aug. 23. Over the three-month period ending Aug. 23, applications for ARMs jumped from 5.4% of all mortgage applications to 7.4%, according to the Mortgage Bankers Association.
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That's not exactly a rush; ARMs made up 25% to 30% of loans during their previous heyday. It is significant, however, considering the poor performance of ARMs during the housing bust and the fact that today's fixed rates are near historic lows.
Of course, the ARMs in the marketplace today are a lot more conservative, thanks to new Dodd-Frank-mandated regulations and tightened underwriting standards, says Keith Gumbinger, vice president of mortgage website HSH.com.
"What came and went were option-style ARMs with a very high frequency of interest-rate changes," he says. "People had monthly payments that kept going up and up and up." Gumbinger says the ARMs that caused the most trouble were those with several layers of risk, from a low or no down payment to payments that did not even cover the interest. "These products washed out of the marketplace," he says.
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Today's hybrid ARMs have longer fixed periods of five, seven and 10 years, as well as periodic and lifetime rate caps to ensure that borrowers won't see a massive jump in their monthly payments. Indeed, Hollensteiner is seeing more consumers opting for the longer terms such as seven or 10 years, as sort of a bridge to a fixed-rate loan. "They are trying to enjoy the benefits of a lower monthly payment but are still protecting themselves" from a rate change, he says.
New rules also ensure that loans can't be made to borrowers who can't document their income or prove their ability to pay the highest rate that might come with an ARM.
The qualified-mortgage rule, which the Consumer Financial Protection Bureau issued and which will take effect in January, requires lenders to underwrite loans based on a borrower's ability to repay. For ARMs, that means the greater of two rates:
- The teaser rate, which is good for the first three, five, seven or 10 years.
- The fully indexed rate, which is the interest rate the loan swings to, depending on the performance of benchmark indexes such as the London Interbank Offered Rate, or Libor.
Of course, given how close fixed rates are to their rock-bottom lows, it's unlikely that rates will do anything but rise in the near term, Gumbinger says. And, he says, your first adjustment could feature a rise in interest rate of as much as 5 percentage points.
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Still, the prospect of shaving a point or more off the rate for the first five years of their mortgage has many borrowers willing to take this gamble.
If it is "getting harder for 1st time home buyers to afford a home" don't you think they aren't ready to buy yet? DUH! They may be able to buy a house with an ARM but will they be able to keep it if the interest rate increases? You need to make sure you can actually live in the house and pay all your other financial obligations (cell phone, cable, food, gas, utilities, etc, etc.) after the mortgage, insurance and taxes are paid! Anyone thinking of buying a house must educate themselves. Remember brokers and agents make money by selling not educating. I got an Amazon ebook called "stuff I told my kids about how to buy your first house" for my own 2 kids (25 and 22) so they can get some basic info BEFORE they see anything with broker. It is a quick read and for less than 3 bucks well worth it in my opinion.
Grandpa always said, "NEVER buy a house with an adjustable rate." Please, people, listen to my grandfather's words! It has worked for me very well. If rates go down, you can always refinance. Anyone who would need an ARM at the current rates really shouldn't be buying a house in the first place. Buying one would only make thing worse in a couple years.
Having experienced a variable rate mortage back in the mid 70's, I can assire you it was a terrible mistake.
Being young and just starting out, we had already paid our first house off. We needed a larger house and accepted our loan officers recommedation. I remember his comment to this day, Oh you shouldn't worry Interest rates are stable". Our credit was good in fact very good. I paid 50% down roughly $35K for 3200 sq ft.. The first year or two nothing changed and we made payments as housing costs increased. After that all hell broke loose and our payment ballooned from $2400 to $6000 in a few short years just in time for the AG depression of the mid eighties. We somehow held on but it was a double whammie a growing family just didn't need. I've never trusted banker's since then and never will again. It did treach me a great life's lasting lesson.
If you can't afford a house today, with the current low interest rates, then I would say you really can't afford a house. I think that the people who opt for the ARM's now, will very likely find themselves in a difficult position when the rates do readjust. The new rules require that they be able to qualify for a house at the higher interest rates. But that's now. They may have no credit debt now. Perhaps they don't have any auto loans, or other bills NOW. But you can be certain that within a very short time after buying a house, they will begin getting a lot of consumer debt. Then that will be the time that the rates readjust and there you have it. A home owner that is stretched to thin and can't make the new payment. That's exactly how it will work.