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ARMs give home buyers a leg up

Adjustable-rate deals coming back in favor

When Brian Bartlett bought a one-bedroom condo in Rosslyn, Va., last month, he asked his mortgage broker to price a range of mortgages, from a one-year adjustable rate to a 30-year fixed rate.

The seven-year ARM ended up giving him the best rate without an uncomfortably short time frame.

“My decision was pretty much to get the lowest rate possible while also managing the risk,” said Bartlett, who is 29 and single. “It was right in the middle, the sweet spot for where I am in my age and my situation.”

Bartlett is one of many borrowers who have considered adjustable-rate mortgages, which fell out of favor during the recession and recovery but were given a second look as the 30-year fixed rate approached 4 percent.

ARMs are considerably less than fixed-rate options. Last week, the 30-year fixed rate dropped to 4.37 percent, still far above the 3.17 percent and the 2.66 percent, respectively, for the five-year and one-year adjustables.

In 2006, ARMs made up a quarter of home loan applications. Since September 2008, applications for ARMs have held a market share of only a few percentage points.

But the recent spike in interest rates, driven by concern about the Federal Reserve Board’s monetary policy intentions, has encouraged some borrowers to find lower rates in the ARM market, where previously they would have been happy with a 15- or 30-year fixed-rate loan, according to analysts and home mortgage experts.

“We’ve seen a significant uptick in the number of people who are considering and taking adjustable-rate mortgages,” said Bob Walters, chief economist at Quicken Loans in Detroit. “For most people, an ARM is a really viable product.”

You may associate ARMs with the housing crisis, because subprime adjustable-rate mortgages were the culprit in many bankruptcies and foreclosures. But the exotic products that got homeowners into trouble were often sold with insufficient or no income documentation.

Moreover, the most deadly mortgages were those structured so that borrowers were repaying only interest or, worse, paying less than required to cover the mortgage interest – termed a negative amortization schedule – which left them paying interest upon their interest payments.

“It’s not ARMs that were exploding, it’s that some of the products that were engineered and the payment methodologies did put borrowers at a disadvantage,” said Keith Gumbinger, a vice president at, a mortgage information website.

“What we have in the marketplace today are more traditional adjustable-rate products.”

In fact, traditional ARMs ended up helping some borrowers during the recession, because as interest rates fell to rock-bottom levels, the mortgages adjusted down and lowered the required monthly payment.

“Historically, a five- or seven-year ARM has performed way better than comparable 30-year mortgages,” said Harris Rosenblatt, a senior mortgage banker with Eagle Bank in Rockville, Md.

Is it right for you?

Before you jump into an ARM, it’s important to understand the product and decide whether it meets your needs, based on your personal and professional plans.

“First and foremost, how long do you think you’ll be living in your home? We know from statistics the average American moves every seven to 10 years,” Walters said. “Most 30-year mortgages don’t last past the 10th year.”

If it’s possible that you’ll move within the next decade, an ARM could make sense. Look at the rates for the variety of products to see how much money you could save for being willing to take an earlier adjustment.

Communications professional Bill McQuillen refinanced from a 30-year fixed mortgage to a seven-year ARM last month to lower his rate from 3.875 percent to 2.5 percent. Once the seven years expire, the most his rate can reach is 7.5 percent, but it would take an extended period of high rates for that to happen.

“I don’t plan to reduce my monthly payment,” McQuillen said. “I plan to keep that the same, which means more money is going straight to principal.”

Make sure you understand the terms of the rate adjustment, and look at some scenarios so you’ll know how high your monthly payment could be if interest rates hit the roof.

“What’s the worst thing that could happen? It’s always the most important question to ask,” Rosenblatt said.

If you are using an ARM to lower the payments to an affordable level, that’s a red flag that you may be making a financially irresponsible move. If the housing crisis taught us anything, it’s that you can’t count on home prices appreciating or the market being hot when you need to sell.

“I do not believe that the adjustable rate should be the key factor in purchasing the property. If you need the adjustable rate to qualify, buy a cheaper house,” said Carl Mazzan, a mortgage loan officer in Virginia who has seen a dramatic increase in demand for ARMs recently.

Although rates have recently ticked upward, they are still very low by historical standards. It’s more likely that in five or 10 years, rates will be higher than they are now. So if you are counting on refinancing at that point, an ARM might not be right for you.

On the other hand, if you are five years from retirement and planning to downsize, or a young couple buying a small home but expecting to expand in three years, you could responsibly choose an ARM that fits your expected time frame.

“For the astute buyer who’s working with a good loan officer who’s willing to ask the right questions, an ARM can save you a substantial amount of money during your time in the property,” Mazzan said.