September 27, 2023

Mortgages: The Appeal of Adjustable Rates

In the first quarter of 2011, while the volume of ARMs sagged along with the mortgage market, their market share actually rose to the highest point since mid-2008, to 12 percent, according to the trade publication Inside Mortgage Finance.

Adjustable rate mortgages generally attract borrowers when rates are high. The rate is set for a specific time — generally one, five or seven years — and then it adjusts to prevailing rates within boundaries. That means payments can go up. Payment shock has caused plenty of problems over the years. Rates can also go down, as borrowers who took out ARMs five to seven years ago are finding now. But it’s tough to imagine how rates could get much lower than now, short of Japan-style negative rates.

“If a person is debt-averse and has a history of paying off his or her mortgage within 5 to 10 years, then he or she would definitely consider an ARM,” said Sari Rosenberg, a managing director of the Manhattan Mortgage Company, a loan broker. “I have another client who knows he is selling his home within the next few years and even with the closing costs he will be saving money,” so he took out a three-year ARM.

Some borrowers, Ms. Rosenberg said, are choosing seven-year ARMs at around 3.5 percent, for up to $1.5 million, an amount typically set by lenders, versus 5.25 percent for a 30-year loan of that size. But, she said, “on a $1.5 million loan, that is a difference of $1,548 a month or $18,576 year. That pays for half a year of private school tuition in Manhattan.”

Keith Gumbinger, a vice president of HSH Associates, a financial publisher in Pompton Plains, N.J., said, “ARMs are good for borrowers with short-term time frames, usually seven years or less.”

“This can include certain first-time borrowers who expect to trade up,” Mr. Gumbinger continued, “such as a single person buying a studio apartment; folks who get transferred, or expect to be, within that time; folks refinancing with just a few more years expected in the old suburban mansion; jumbo mortgage seekers looking for a lower-cost alternative, and even folks who are approaching retirement age who want to seriously improve their cash flow to maximize their retirement accounts.”

Conversely, ARMs aren’t wise for borrowers who plan to stay put, Mr. Gumbinger said, or those who would have trouble managing rising payments. That includes people who expect cash-flow strains, such as those starting a family.

Another choice faces borrowers whose five or seven-year ARMs are resetting now, said Gary Schatsky, a financial planner at in New York City. Rates may drop to 2.25 percent to 3.25 percent from about 5 percent. That compares with around 4.5 percent, on average, for 30-year fixed-rate loans now. But that super-low rate is good for only a year.

“It’s very seductive,” Mr. Schatsky said, especially because keeping that ARM rather than refinancing into a fixed-rate loan avoids closing costs.

In that case, he said, know how much your rate could jump after a year — ARMs generally have caps on increases — and whether you can handle that. “I want you to have a Plan B,” he said.

IN the meantime, he counsels clients to consider using the savings to pay down the loan, rather than spending it.

And borrowers who are nervous about higher future payments should consider forgoing the alluring new rate, he said.

“If you have no room subjectively for the risk,” Mr. Schatsky said, “it’s not a bad time to say it’s been a good ride, but it’s time to go from adjustable to fixed.”

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