Wouldn’t it be nice to have a mortgage where the interest rate begins with the number “3?”
More borrowers seem to think so, as more of them are opting for adjustable-rate mortgages, whose rates have become even more alluring compared with fixed-rate mortgages.
The rate on a 5/1 adjustable-rate mortgage — that is, a loan where the interest rate is fixed for the first five years and adjusts annually thereafter — is 3.23 percent on average, or about 1.35 percentage points less than a traditional 30-year fixed-rate mortgage, according to HSH.com, which publishes mortgage and consumer loan information.
Lured in by the attractive rates, about 12 percent of the $325 billion in new mortgages made were adjustable-rate loans, known as ARMs, in the first quarter. That compares with 9 percent of new mortgages issued in the fourth quarter of last year, according to Inside Mortgage Finance, a newsletter that tracks the mortgage industry.
During the housing boom, borrowers — especially those with spotty credit histories — took out ARMs in droves. In 2006, 45 percent of mortgages issued were ARMs. But we all remember how that movie ended: Just as many of these borrowers’ loans were about to reset to a much higher rate, the housing market crashed and many people couldn’t refinance into another loan with a more manageable monthly payment. In many cases, borrowers didn’t fully understand what they were signing up for, since the loans carried complex features that either weren’t disclosed or were hard to comprehend. Others simply got in over their heads.
“By and large, the ARM market was polluted by the abuses that went on with subprime mortgages,” said Guy Cecala, publisher of Inside Mortgage Finance, adding that “prime” mortgages sold to borrowers with solid credit histories tend to have much clearer terms. Now, “both borrowers and lenders are getting more comfortable with ARMs again.”
The ARMs being used most frequently are known as hybrid ARMs, which means there’s a period, say three or five years, where the interest rate is fixed. That offers some protection against a spike in interest rates, but there’s still the possibility your payments may rise to a less manageable level later (and that you won’t be able to unload your home if you need or want to sell).
Consider a borrower with good credit who needs a $200,000 mortgage. A 30-year fixed mortgage will carry a rate of about 4.49 percent, which translates into a $1,102 monthly payment. But the borrower could save about $128 each month by taking out a 5/1 ARM with a 3.375 percent rate, which translates into a payment of $884 per month. Over five years, that’s a savings of about $7,680.
“If you know you will sell the home within five years, then it’s a no-brainer,” said Rick Cason, owner of Integrity Mortgage, a mortgage firm in Orlando, Fla., who provided the numbers. “But most people are unsure about what the future holds for themselves or the housing market.”
That’s why it’s important to understand the inner-workings of the ARM, if you decide to go that route. All traditional ARMs have caps and floors, which state how much the rate can change over the life of the loan.
For instance, the typical 5/1 ARM has what’s known as a 5/2/5 cap, explained Mr. Cason. Here’s how that translates into English, using the loan with an initial 3.375 percent rate: The first “5” determines how much the rate can increase (in this case, five percentage points) above the initial rate during the first year after the fixed period is over (So it can climb as high as 8.375 in year 6).
The “2” is the maximum amount the rate can change in any year after that. And the last “5” is the maximum amount the interest rate can adjust from the original rate over the life of the loan. So, at least in this case, the loan wouldn’t rise above 8.375 percent. But all borrowers should make sure they can afford to make payments based on that higher rate, should the worst case actually happen. (You can run the numbers yourself, using different interest rates, on an amortization calculator).
Now you can see why Elizabeth Warren wants to make sure all of this is explained in plain English.
When Mr. Cason walks his clients through the details, he said most of them decided to stick with the stodgy but reliable 30-year fixed loan. “Fixed rates are too low without the risk of adjustment in the future,” he added. “I am not seeing many people in Orlando choose an ARM product.”
What do you think about ARMs? Would you take one now if you figured that you would be moving in three to five years?
Article source: http://feeds.nytimes.com/click.phdo?i=60aebf96b8109976357e97da2cdc3479