Why We Have an Adjustable Rate Mortgage
We have an adjustable rate mortgage and it’s a good thing! Adjustable Rate Mortgages (ARMs) have been blamed recently for a lot of the housing troubles going on. However, adjustable rate mortgages do serve a purpose and meet the financial needs for some people, including us. We carefully selected the best product to match our financial situation.
Benefits of our adjustable rate mortgage
If an ARM works the way it is designed, the potential for significant savings is one of the key selling points. Here’s more benefits:
- Lower interest rate and lower payments resulting in more money to invest for our long term goals.
- If interest rates were to drop when our loan adjusts, we would automatically be able to have the lower rate.
- Ability to save money if we don’t stay in the house long term.
Not all adjustable rate mortgages are created equal
We obtained our ARM from a reputable lender with good terms. Without some of these safety precautions, I wouldn’t necessarily have considered one:
- No prepayment penalty.
- Limited caps (maximum percentage increase) on both the annual adjustments and total adjustment.
- Hybrid 5/1 term that provides a fixed option for the first five years and adjusts annually after that.
Our Housing History
How long you stay in the house is critical to determine whether or not an ARM is appropriate. If you are staying a long time (10 years or more) a fixed rate is probably a better deal. If you’ll be moving before that, an ARM may be appropriate. This was the case with our last two houses. Our first was a starter house that we didn’t plan to live in long term. We had a 7 year balloon. We actually moved out in 9 months, but that’s another story! Our initial plan was to stay for 5-7 years.
Our last home, a condo, we had a 2/2 ARM from Pentagon Federal Credit Union. It was an adjustable rate that adjusted every two years, with a max adjustment of 2% each time. We locked in at 3.625%. We lived in the condo 3 years until we built our current house and realized substantial savings over a fixed mortgage.
I’d love to tell you that we’ll stay in our current house forever, or a long time, but I know myself better than that! Having said that, we’ve been in the house 2 years and currently don’t have plans to move.
What happens after the 5 years are up?
I’ve been investing with the intent to have enough money to pay off the house in 9 years, coinciding with our dollar plan. We’ve given ourselves the option to ride out the interest rates. However, I’m also ready to refinance if we need to. In fact, it is one thing I might consider if I decide to stay home from work.
After it starts adjusting, if we are no longer comfortable with the annual changes in interest rates we can do one of the following:
- Refinance for another 5 years until we have enough to pay it off.
- Pay off the portion we have saved.
- Or do a combo of the above.
When an Adjustable Rate Mortgage is the Wrong Choice
An ARM fits our current financial situation. I would probably opt for a fixed mortgage if some of the following were true:
- I had any certainty that we would stay in our house for 10 years or more.
- We didn’t have a plan to have savings available to pay off our mortgage after the adjustment period.
- I was risk averse.
- We couldn’t afford the maximum interest rate change that ours could adjust to.
- We couldn’t afford our house without an ARM.
Examples of situations where an ARM was not appropriate:
- Stupidity got us into this mortgage mess
- The Housing Bust Aftermath is Turning the American Dream into an American Nightmare
While I believe a 5/1 ARM is right for us, I probably wouldn’t feel comfortable with a 1 year or 3 year ARM. Five years is about the minimum I would go. If the price difference wasn’t substantial between the 5 year ARM and the fixed rate, I would likely choose the fixed rate.
We also didn’t finance our entire house with our mortgage. We put down 20% and do not pay PMI. We also financed some of our house with student loans locking in really low rates that will not adjust. So in a sense, we do have a fixed portion.
I’m a risk taker. I’m willing to take the risk that the interest rate will adjust in exchange for a cheaper price upfront. It’s the same reason that I don’t lock in long term savings vehicles like CDs. I’m willing to go where the market will take me. Sometimes it will be up and sometimes it will be down. I’m willing to take the risk that I might not come out ahead for the chance that we will save significantly.
Are evil adjustable rate mortgages the root of the housing crisis?
ARMs are being blamed as part of what got us into the housing mess. However, it’s the choices that people made and not the product itself that is the root cause. There are definitely people that should not use an ARM, and then there’s a group of people who the ARM makes perfect sense for. Since I fall in the latter group, I’d hate to lose a product that suits us because others couldn’t use it wisely. I’ll be watching the government regulation to see what becomes of the current lending practices.
I do have compassion for people who used a trusted advisor, or believed they had someone working on their behalf and got an ARM without understanding how it works and what would happen when it starts to adjust. It’s why I also believe financial education needs to have more emphasis on it to empower people to learn and make the right decisions.
I paint a pretty picture for our house and an ARM, and the truth is that the worst can happen to anyone. However, I feel that we have put appropriate safeguards in place to guard against it. We’ve saved a lot of money by choosing the right financing to meet our needs.
Thanks for sharing all this. I’ve never used ARMs or even studied them b/c of all the negative I hear about them. I understand there are situations when they are applicable though. Yours seems to be the case.
I’m curious if you can put a dollar amount to the savings you’ve seen/expect to see from going ARM vs fixed?
Rates are falling, actually a good idea to have an adjustable in this environment. You nail another one!
I too am in the same boat as you. We have an ARM at 3.375, with fixed adjustments and a cap on the lifetime high it can go. We never thought we would be in our house for 5 years but we are slowly creaping up on it. I hasn’t made sense to refi before now because our rate was so low.
I agree that these are a good product but not when the are used abusivly. Everyone thinks we have a subprime loan because we have an ARM, and the truth is all ARMs are not created equally. They surely have gotten a bad wrap in the last few years.
Don’t know your rates, but I believe the student loans cease being tax deductible at a certain income level. I hope it’s worth financing the home with the student loans versus a mortgage!
An excellent article. Like ARMs, there are many products out there that are manna from heaven for the savvy and at the same time poison for the uninformed and irresponsible. Good for you for being smart and understanding the product you bought.