Adjustable rate mortgages have taken a bad rap and were partly the blame for the sub-prime mortgage crisis back in 2007 and 2008. Truth is, adjustable rate mortgages are a great mortgage tool, if used correctly. It allows for a lower rate versus a fixed rate which results in a lower mortgage payment. Its how you use it that will determine if it benefits you or hurts you.
When to use an ARM
ARM’s (adjustable rate mortgages) typically come in 3, 5, 7, and 10 year time periods. This means your rate will be fixed for the for first 3, 5, 7, or 10 years. After this period ends, then your rate will adjust based on the LIBOR or SIBOR. Typically the rate will increase which increases your payment.
You would typically use an ARM for the following reasons:
Time: If you know that you are not going to live in a house more than three years, then it may be advantageous to be risky and get a 3 or 5 year ARM. This will allow you to get a lower payment and keep more money in your pocket.
Lower payment: If you can not afford the payment of fixed mortgage, you can elect to get a 3 or 5 ARM to keep the payment low enough so you can afford it. However, during this time period, it is important that you work on your credit and finances so that you can refinance when your ARM is set to adjust or when fixed rates are looking sexy.
When not to use an ARM
Its very important that you understand the mortgage product you are selecting when purchasing a house or refinancing. If you want to be in your home for the long term (over 10 years), then an ARM is not the right product for you. Don’t allow yourself to be put in any mortgage product for the sake of qualifying for a house. If the only way you can qualify for a house is through a ARM mortgage, then you really can’t afford the house. Sounds simple enough, right?
What happened during the mortgage crisis?
A lot of people in the urban community were given ARM mortgages in order to get a lower payment. However, these same people had very low credit scores and a poor credit history. Why does that matter? It matters because when their ARM expired, they didn’t have a high enough credit score to refinance. Real estate markets change all the time. Guidelines change all the time. What was acceptable 2 years ago may not be acceptable today. So the only option was to sale of foreclose on the property. This where an ARM mortgage product can hurt you. Bottom line, they should have never been put in an ARM mortgage anyway.
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