The Right ARM Can Be a Great Loan for a First Time Buyer
People often shudder when they hear the term adjustable rate mortgage, otherwise known as an ARM. There have been many different kinds of adjustable rate mortgages throughout the years, some open to drastic rate changes or even balloon payments. However, not all ARMs are created alike.
Without getting too deep into the details, the most important details you’ll want to examine when evaluating an ARM are:
- When can the rate first change? This is the first number in the name of the ARM – a 10/1, for example, could change after the first 10 years.
- How often can the rate change after that first change period? That is the second number in the name of the ARM. For example, a 3/3 ARM can only change once every 3 years.
- Rate Caps: What is the maximum rate increase allowable during a change? Some loans can only change the rate a maximum of 2% during a change period. Contrary to what you might assume, rates do not only go up. Sometimes, they go DOWN.
- Rate Caps over the life of the loan: In addition to restrictions on how much a rate can change during rate change periods, there is also a cap on how much the interest rate can change over the entire life of the loan.
- What index is being used to determine the rate? The most commonly used indexes are the CMT, the LIBOR and the COFI. You can find these rates published online and in various periodicals. The Consumer Finance Protection Bureau (CFPB) published a very helpful handbook on ARMS that demonstrates those rate changes over 11 years and discusses other indexes.
- What is the margin? The margin is the percentage amount that is added to the indexed rate. For example. The current CMT index is 1.8%. If the margin on your loan is 2%, then during the loan’s rate change period, if your rate is lower, then it would go up to 3.8%.
A personal detail to consider when getting an ARM is how long you expect to be in that home. If you’re purchasing your first home, there’s an excellent chance that you’ll be selling that home to buy another within 5-7 years. If that is the case with a 10/1 ARM, then you would already be out of that loan before it’s eligible for a rate change anyway.
If you do not buy another home before the rate changes, you may consider refinancing depending on what’s happening in the market.
Additionally, you may be expecting your income to increase over the next several years. In that case, it makes sense to start out with smaller payments using an ARM. If you have some extra money, you could also choose to make extra payments during the time of the lowest interest rate, thus paying off more of the loan and increasing your equity.
Comparing Suncoast’s Current First Time Buyer 10/1 ARM & an FHA 30 Year Fixed Loan for a $225k Purchase
|Suncoast 10/1 ARM||FHA Loan|
|Down Payment||3% ($6750)||3.5% ($7875)|
|FHA Funding Fee (added to loan)||0% ($0)||1.75% ($3799)|
|PMI (Private Mortgage Insurance)*||$0 /mo||$152.69 /mo|
|Principal & Interest Payments||$995.33||$1135.86|
|Escrow (for taxes & insurance)||$225||$225|
|Total Monthly Payment||$1220.33||$1513.55|
*PMI (Private Mortgage Insurance) is charged by most banks for mortgages with less than 20% down (borrowing more than 80% of the home’s purchase price). Suncoast ARMS do not charge PMI.
***These figures are solely for general comparison of two different types of loans; they are not intended to be used as actual cost estimates. Borrowers must apply with the lenders of their choosing in order to get estimates based on their individual circumstances and current interest rates.
From the above comparison, you can see that the Suncoast loan yields considerable savings. Using our fictional buyer and sale, monthly payments on the Suncoast loan are $293 less per month than using the FHA loan. The down payment on the Suncoast loan is $1125 less than on the FHA loan, and the total loan amount of the Suncoast loan is $2675 less than using the FHA loan.
Two helpful tools you can use for general comparison of these two loans are Suncoast Federal Credit Union Loan Wizard and What’s My Payment’s FHA Calculator. In order to compare actual loan offers, the borrower must apply and then compare the actual estimates.
The basic details of this current Suncoast 10/1 ARM are as follows:
- Must have not owned a home for at least 3 years to be considered a first time buyer.
- Interest remains the same for the first 10 years and can change annually after that.
- Rate caps are max 2% during an adjustment period (up or down) depending on the CMT index.
- The index is the CMT and the margin is 2.5%
In this example, worst case scenario if you kept the home for ten years until the first rate change and the rate increased by the maximum 2%, your payments would go up from $1220.33/mo to $1496.76. Since the index used (CMT) is publicly available, the borrower should keep an eye on the market as the first change period approaches. If it appears that payments will continue to increase, the borrower could choose to refinance at that time.
ARMs are more risky than a 30 year fixed, but depending on your personal circumstances, the lower interest rate to start combined with the savings of not paying PMI may be worth it for you. It’s strongly recommended that buyers get more than one loan estimate in order to compare and decided which is the best fit for their needs. The CFPBs Home Loan Toolkit is an excellent resource for understanding and comparing different loans.
Contact me today to get connected with loan officers who can help you explore your mortgage options and/or get a pre-approval.
For more information on ARMs consult CFPBs Consumer Handbook for Adjustable Rate Mortgages (CHARM).
***Program details were gathered from web pages linked in the article and are subject to change without notice. They are presented for basic informational purposes only. Last updated: 2/22/2018. Neither Tracy Wisneski nor People’s Choice Realty Services, LLC accept responsibility for details on these loans.