Hello to ARMS: Variable-Rate Loans Make a Comeback

weighing ARMs against fixed-rate mortgagesRoundly blamed as one of the key reasons behind the collapse of the housing market, the once-popular ARMs--adjustable-rate mortgages that started low and then adjusted to higher and less affordable payments--have crept back into the marketplace. The home-loan product that was virtually eradicated during the housing bust is now claiming about a 6 percent share of the market, according to the Mortgage Bankers Association. In 2006, ARMs were a steady 30 percent of the loans being written; by 2008, they'd fallen to less than 1 percent of the market.

The ARMs of 2011, however, bear little resemblance to the ARMs of 2006.Gone, for the most part, are the loan rates that fluctuated monthly. Gone too are the loan products that lured you in with next-to-nothing interest rates but quickly rode the elevator up to the level where people were forced into foreclosures. Today's ARMs have lifetime caps and stay flat for initial periods of three, five or seven years.

Still, can we trust them? Be prepared for the mortgage industry equivalent of, "It's not guns that kill people; it's people who kill people."

"There were good ARMs and there were bad ARMs," says Michael Moskowitz, president of the New York-based Equity Now, a direct mortgage lender. Moskowitz is one who believes the baby shouldn't be thrown out with the bathwater. The product has its place, he says, and it behooves people to consider an ARM in certain home-buying situations.

Certainly people are drawn to these loans now for the same reasons they were a sought-after commodity in the housing boom years: They offer cheaper monthly payments. Most agree that for buyers who don't intend to stay in the house beyond the fixed-rate period (typically five years), this is a legitimate and safe way to save money. For example, if you're borrowing $400,000, a five-year ARM offered at the current 3.125 percent interest rate would result in a monthly mortgage payment of $1,730.50. The same loan at a 30-year fixed rate of 4.5 percent will have you writing a check for $2,026.74 each month. That's an approximate $19,000 savings over the five years of the ARM.

The buzzword in mortgage circles today is suitability, says Chris George, founder and CEO of CMG Mortgage in San Ramon California and secretary of the California Mortgage Bankers Association.

"Is it really suitable to put a couple of 80-year-olds in a 30-year fixed-rate loan?" he asks. "They aren't going to be around to see that mortgage paid off."

George joins the growing ranks of professionals willing to look at ARMs again with a fresh eye. "Any time interest rates tick up, you can see a greater demand for alternatives that are lower," he says. But common sense -- in the form of loan qualification standards -- has to be applied. "You don't give your brand new car to your 16-year-old new driver," he said, "and you don't give a loan to someone without requiring proof of their income or ability to repay it."

The key to what kind of loan is best for you is how you answer the question: How long do you intend to live in the house? If you intend to live in the home for longer than the term of the ARM, things become more of a gamble.

So how long do we actually live in our houses? The median home ownership is now eight years, according to the National Association of Realtors. This is up from just six years in 2007 -- probably a reflection of the housing market crash, tightened lending standards and the overall economy, which shed 8 million jobs. But NAR spokeswoman Stephanie Singer also notes that a recent NAR study found most recent buyers saying they intend to live the next 10 years in the home they just bought.

What's sobering is how many people don't actually understand the mortgage game. A new Zillow Mortgage Marketplace study found that almost 60 percent of prospective home buyers don't understand how ARMs work. When they were asked if interest rates on a 5/1 ARM always reset to a higher rate after five years, most answered yes. In truth, the rate adjusts to whatever the prevailing rate is in five years, which means they could go down.

The moral of that story is, whether you choose a fixed-rate or an ARM, do your research and know what you're getting into up front.

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