Youâ€™re buying property and might be considering an Adjustable Rate Mortgage (ARM), with interest rates and payments that can fluctuate over time. Right now, ARMÂ mortgage rates might meet your real estate goals better than fixed rate mortgages.Click to see today's rates (Sep 23rd, 2017)
Fixed-rate mortgage interest rates and payments stay the same throughout the loanâ€™s life. That's what makes them so popular with homebuyers.
In contrast, ARMÂ interest rates adjust periodically throughout the loan's lifetime. Fluctuations in the interest rate -- and your payments -- depend on your mortgageâ€™s terms.
These loans arenâ€™t as scary as they once were, which is why youâ€™re probably considering one. Here's what you need to know about ARM rates.
When mortgage lenders make fixed-rate loans, they have to deal withÂ interest rate risk.Â That's the chance that interest rates will rise, forcing them to payÂ more to depositors or investors, while they continue to receive the same low, fixed payment from their borrowers.
ARM loansÂ transfer some of that risk from the lender to the borrower. In exchange for assuming some of this risk, you get to pay a lower interest rate -- at least during the first years of your loan.
That difference in interest rates between the two types, aka the spread,Â makes ARMs more appealing than they would otherwise be..
The chart below from Freddie Mac shows how the difference between 5/1 and 30-year loans changed over the last year.
An important feature of ARMs isÂ what's called an introductory rate, a teaser rate, or a start rate.
It'sÂ the rate lenders use when they advertise an ARM. And this rate applies only during the loan'sÂ introductory period, which can range from one to ten years.
ARMs are named after this period: 1-Year, 3/1, 5/1, 7/1 and 10/1, for instance.
Pay attention to that first number; it shows how long the introductory period is. The loanâ€™s fixed rate will be one, three, five, seven or ten years.Â The lower that first number, the shorter the fixed term, and the lower the rate should be.
The second number shows how often your interest rate will adjust after that fixed-rate term ends. For the loans listed above, it's annually. A less-common loan is the 3/3 ARM, which adjusts every three years over its life.
Mortgage rates for ARMs vary depending on the financial indexes the lenders use. The London Interbank Offered Rate (LIBOR) and 1-Year Treasury (CMT) are two of the most common. You can find them online on just about any financial site.
As of this writing, for instance, the 1-Year LIBOR rate is 1.76 percent, and the 1-Year CMT index is 1.20 percent.
Lenders add a percentage called the margin to the index when it's time for your ARM to adjust or reset. The history of a specific indexÂ shows you how your rate could fluctuate over time.
If you have a 5/1 LIBOR ARM, for instance, and it has a 2.5 percent margin and is adjusting today, your new rate would be 2.50 percent plus 1.76 percent, or 4.26 percent. The average 1-year LIBOR rate over the last decade was 1.96 percent, so if the index hit its average, your new rate would be 4.46 percent.
Are you completely at the mercy of your loan's index? No, thanks to a few safety features these loans have, called periodic caps and lifetime caps.
First, there is a limit to how high your rate and payment can go at its first adjustment. That is typically two or three percent, depending on the length of your fixed-rate period.
So, if your 5/1 ARM was fixed at 2.25 percent for its first five years, and the cap on its first adjustment is two percent, the highest your rate could go is 4.25 percent. If your annual cap is also two percent, the highest your rate could go the following year is 6.25 percent.
But that's not all. A lifetime cap ensure your interest rate wonâ€™t rise more than a set amount over the loanâ€™s life. It may be expressed as a percentage above your start rate, or a maximum interest rate.Â Federal law requires lifetime caps on most ARMs.
When youâ€™re pretty sure youâ€™re not staying your home more than your ARMâ€™s introductory period, you can save a lot of money with an ARM. Since the average time people stay in home is seven years, a 5/1 or Â a 7/1 ARM is ideal for most buyers.
It actually may be smart to avoid a fixed rate loan for a starter home or any house you know youâ€™ll keepÂ fewer than 12 years, says Mortgage Professor Jack Guttentag. "Beyond that," he states on his Web site, "The cumulative effect of rate increases will probably outweigh the benefits of low rates in the early years."
Usually, however, if youâ€™re staying beyond the initial fixed rate period, you can refinance into another ARM. Be as knowledgeable as possible and know your options before choosing ARMs, so they remain the cheaper option.
Current ARM rates are very attractive, with the 5/1 coming in this morning at 3.25 percent. That's the same as the 15-year fixed rate, but you don't have to make a high 15-year payment to get it. You can compare rates for all ARMs from various lenders online and choose the best loan for your situation.Click to see today's rates (Sep 23rd, 2017)
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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2017 Conforming, FHA, & VA Loan Limits
Mortgage loan limits for every U.S. county, as published by Fannie Mae & Freddie Mac, the Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA)