Monday, April 3rd, 2017
With interest rates on the rise, it may be time for home buyers to take a fresh look at some alternatives to the 30 year fixed rate mortgage, which has dominated the mortgage market since the 2008 financial crisis.
While many non-traditional loans got a black eye after the housing collapse, today’s versions lack the toxic features—such as negative amortization and prepayment penalties—that tripped up many borrowers during the housing bubble a decade ago
So-called hybrid adjustable-rate mortgages, or ARMs, are especially suitable for borrowers who expect to move before any rate increases can wipe out the savings in the early years. They’re also useful for more sophisticated borrowers wrestling with uneven income, borrowers who expect their income to rise, or borrowers who are willing to bet they can invest their mortgage savings for a greater return elsewhere.
Many borrowers can find a sweet spot, for example, the 7/1 ARM, which carries a fixed rate for seven years before starting annual adjustments. With a typical rate of 3.75%, the monthly payment on a $300,000 loan would be $1,389, compared with $1,449 for a 30-year, fixed-rate loan at 4.1%, saving the borrower $5,040 over seven years.
Even if the loan rate then went up, it could take two or three years for higher payments to offset the initial savings, making the mortgage a good choice for a borrower likely to move within 10 years. Once annual adjustments begin, they are generally calculated by adding a fixed margin to a floating rate, such as the 1 year LIBOR (London interbank offered rate).
While not for everyone, hybrid ARMs will become more popular if rates continue to rise as they are expected to. With ARMs ‘hybrid fixed’ terms ranging from 1 month to 15 years, savvy borrowers have a lot of ways to save money compared to traditional 30 year fixed rate mortgages and should be considered depending on their situation.