This morning, one of my home-buying clients asked me to explain the difference between a variable rate mortgage and a fixed rate. Although she knew the basics, she wondered why, whenever she mentioned to her friends how much lower the rates are on variable loans, they were immediately horrified and warned her away from them.
Now, I’m not a mortgage expert, and I even referred my client to one, but I can take a stab at this question and probably do a halfway decent job in busting some of the myths that surround variable rate mortgages.
1. Variable rate mortgages are scary
The housing crisis, the bursting of the housing market bubble, the Great Recession, whatever you want to call what we went through economically in the mid-2000s, it affected most Americans to one degree or another. Homeowners were hit hard, especially those that took out the so-called “liar loans,” that required no documentation other than evidence of a heartbeat. The no-doc, no-ratio ARM products were all the rage, and lenders were handing them out like cookies, regardless of a borrower’s ability to pay. What better way for cash-strapped homebuyers to get into homeownership and have a manageable house payment than with the lowest rate on the market?
The problem was, jobs dried up. Millions of Americans became unemployed and, regardless of how low their house payments were, it was impossible to pay them with unemployment checks. Home values tanked as well and even selling the home to get out from under the burden wasn’t working. When the adjustable period kicked in, many simply walked away from their homes.
Naturally, the government stepped in when the dust settled and proof of “ability to pay” is something that was insisted upon in mortgage lending. The ARM is still around and presents a valid alternative to the fixed rate mortgage for many buyers.
2. ARMs are aren’t a good option while the Feds are raising rates
This myth stems back to the days of the 2008 recession. It’s like saying, “dial-up is the fastest way to access the Internet,” it’s just not true anymore. All ARM loans have annual and lifetime caps, so there’s built-in protection. If stability is what you’re concerned with, consider an ARM with a longer adjustment period.
For example, Navy Federal Credit Union’s 5/5 ARM adjusts only once over the initial 10-year period. Or, consider the 5/1 ARM, where the rate is fixed for the first five years and then adjusts every year. Many buyers pursue one of these products, planning on refinancing before the variable period kicks in.
Your lender, who knows your financial situation, is your best counsellor when it comes to making a decision between loan products.
3. ARM rates aren’t that much lower than fixed rates
“The potential savings on an ARM can range from $10,000 to $20,000, compared to a 30-year, fixed rate jumbo mortgage,” said Katie Miller, Navy Federal vice president of Mortgage Lending. “That’s enough money for a down-payment on a car, or part of your child’s college tuition.”
Again, it pays to plan for various scenarios based on how long you plan to own the home. Check out an ARM vs. Fixed-rate Mortgage Calculator to see if this type of mortgage works for you