Flexing the ARMs

Mortgage and Lending with Mason-McDuffie Mortgage, Conventional Loans, Jumbo Loans, FHA, 203(k), USDA, VA, NMLS #138061 MMCD #1141

Flexing the ARMs


     In the mortgage industry, there are some dirty words.  Aside from the more obvious ones like "denied" and "dead deal" are some that are more industry jargon than well understood concepts.  When speaking with a consumer, many lenders fear the mention of these dirty words might cause borrowers to look elsewhere, so many times the words are never spoken.  One of these dirty words is "points" and I just did a write-up that hopefully helps clean that one up.  Another word amongst the dirtiest to many borrowers is "ARM".

ARM loans


     I know, I know, ARMs are the devil - the sole reason for the mortgage market meltdown just a few years ago - but hear me out.  Unlike that ex-  that just texted you a hello a couple months after your tenth break-up, ARMs really have changed!  They're more stable, safer, and offer a ton of benefit to the right borrower.  Who is the right borrower?  Well, I'll get to that in a minute, but let's just say it's a lot more people than you might think.



     A few years ago, ARMs were a big part of the wild west that was the mortgage industry.  Lenders could offer ARMs that were fixed for just 2 years, but were strapped with prepayment penalties of 3 years - this meant that when an ARM adjusted upward, a homeowner was forced to either pay a grossly inflated payment, or to pay a ridiculous sum to refinance (or, even worse, sell their home).  That nonsense is a thing of the past.  There are no more prepayment penalties that outlast an ARMs fixed term, and there are no unstable features attached to today's ARMs like 40-50 year amortization plans, or negative amortization possibilities.  Today, ARMs are the good guys.



So what is an ARM?


     Simply put, it's an acronym for Adjustable Rate Mortgage.  ARMs are usually seen written as 3/1, 5/1, 7/1, or 10/1 ARMs - the first number indicative of how long the loan has a fixed rate period, and the second number indicating how often the ARM's rate can adjust.



     So a 10/1 ARM is a loan amortized over 30 years, but it's fixed for the first 10 years before it begins to adjust.  It can then adjust every 1 year after, until it's paid off at year 30.  Usually the shorter the fixed rate term, the lower the interest rate.  So interest on a 5/1 ARM is usually lower than a 10/1 ARM, and both always have a lower rate than a 30 year fixed rate mortgage.



Who should use an ARM mortgage?


     In a recent study it was shown that the average buyer of a single family residence stays in that home for 13 years.  With a 10/1 ARM as an option, ARMs aren't a bad idea for the average home buyer.  The 3 extra years, even if rates rise, would follow at least 10 years of savings.  While ARMs are a good option for the average home buyer, they're a GREAT option for certain situations:


Short term ownership


     If a buyer knows they will not have a property longer than 10 years, there is NO reason to have a 30 year fixed rate.  On average, a 10/1 ARM offers an interest rate of about .25 lower than a 30 year fixed rate.  That means over the first 10 years of a $300,000 mortgage, someone with a 10/1 ARM would save $5,000 over someone that chooses a 30 year fixed rate.  With shorter term loans and the use of a 7/1 or 5/1 ARM these savings increase drastically.



Borrowers with future earning potential


     Ever hear of those wonderful "doctor loans" where doctors can obtain 100% financing with no PMI?  Yep, most of these are ARM loans, based on the fact that doctors recently out of school have large long term earning potential.  Borrowers can use an ARM to get a lower payment now to fit their current income, and as their earnings increase, they can afford the mortgage payments IF their loan adjusts in the future.  IF the loan doesn't adjust (or better, adjusts downward), they can just continue to enjoy the savings.





     Investors can find creative ways to take the interest savings offered by an ARM and earn interest on it, increasing their portfolio or perhaps injecting a business with liquidity.  One of my most financially savvy clients has repeatedly borrowed against his home with ARM loans to grow his business and income, and then pay off the ARM before it even comes close to it's adjustment date.



FHA borrowers


     FHA offers ARMs with an added benefit to the lower initial interest rate.  FHA ARMs, once they hit their adjustment period, can adjust a maximum of 1% each year.  This is great for first time buyers who need to use FHA to finance their home, and likely won't be in that home much longer than 5-7 years.



Who shouldn't use ARMs





     Wait, didn't I say investors should use ARMs?  Well yes, but those investing heavily in real estate could get quite a shock if the payments on all their properties adjusted at once!  Real estate investors with the ultimate goal of free & clear properties that come with a monthly rent check should stick to short-term fixed rate loans to make that dream a reality.



Long term borrowers


     Found that forever home?  Stick with a fixed rate, unless you can afford payment bumps along the way.  After the initial fixed rate period is over, ARMs can fluctuate annually (some fluctuate monthly) and if you can barely afford the fixed rate payment, you can get in trouble if you see a big bump.



Those with tight finances


     ARMs should never be used to qualify for 'more house'.  If you can't afford a home with a fixed rate loan, you can't afford the home with an ARM, either, despite what your lender may tell you.  ARMs should be a financial vehicle and part of a financial plan, not a way to get into a house with the hopes you can improve financially before the adjustment period rolls around.  ARMs are for people with plans, not hopes.



Some important things to know about ARMs


How ARMs adjust


     ARMs are usually tied to a financial index, and a lender offers loans based on this index, plus a margin.  After the fixed rate period of an ARM ends, the rate becomes the index plus the margin.  It's important to know what index & margin your ARM is based on, as there are several out there.  One of the more common is the LIBOR index.



Is there a limit to how much an ARM can adjust?


     Yes.  ARMs can't just keep growing, and growing.  Generally, for FHA loans there is a lifetime cap of 5% higher than the start rate (remember, FHA can only increase 1% per year though) and conventional loans have a normal cap of 5-6% over the start rate.  Many times, there are safety caps in place to prevent large increases from happening immediately after a fixed rate period.



Know your caps


     As I mentioned above, ARMs have caps.  You may get an ARM with 6/2/6 caps, or 2/2/5 caps, or 1/1/5 caps (FHA).  What do these numbers ARM ratesmean?  Well, the first number is the maximum % your loan can adjust immediately after the fixed rate period comes to an end.  The second number is the maximum % the loan can adjust annually thereafter.  The final number is the maximum % the loan can ever adjust.



     Let's say you have a 5/1 ARM with 2/2/5 caps, and your fixed rate for the first 5 years is 3%.  Once that 5 years is up, the maximum the loan can adjust to for year number 6 would be 5% (your initial 3% rate, plus the 2% first adjustment cap).  The max it could adjust to the following year would be 7%, and the max it could adjust to the following year would be 8% (your initial 3% rate plus the lifetime cap of 5%).  The loan could never adjust higher than the 8% established by the lifetime cap.



     The caps, like the ARM's fixed term, is generally a game of risk VS reward.  Just as a 5/1 ARM has a lower rate than a 10/1 ARM, a loan with caps of 6/2/6 will likely have a lower initial interest rate than a loan with caps of 2/2/5.  The higher the risk, the higher the reward (a lower initial rate/payment).  For long term planning, it's a good idea to use an ARM with more conservative caps.  If your plan includes getting rid of the loan before the fixed rate period ends, you can see some additional savings by getting a loan with higher initial caps.



     ARMs are a tremendous tool, allowing financially savvy buyers to save a TON of interest.  Yes, there's risk, but for a borrower that knows what they're doing, has a plan, and has an experienced mortgage loan officer as a guide, an ARM can play a big role in wealth building and obtaining a mortgage loan that best fits your financial plans.



Have questions on ARM loans or any of the other dirty words in the mortgage industry?  Feel free to give me a call at 484.680.4852 or get an instant answer from an expert by clicking here.



Re-Blogged 3 times:

Re-Blogged By Re-Blogged At
  1. Joy Daniels 11/07/2014 09:37 AM
  2. Praful Thakkar 11/09/2014 02:15 PM
  3. Peter Mohylsky, SoWal Is HOME. 05/13/2016 10:20 PM
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Carla Muss-Jacobs, RETIRED
RETIRED / State License is Inactive - Portland, OR

A little off topic, but the ARMS weren't all the problemo with the meltdown, it was rates going through the roof, prices dropping, re-financing with money out on fake equity.  Anyway, a good ARM is a good ARM.  I used ARM's to my advantage over the years.  But, with everything in life, all things in moderation.

Nov 07, 2014 11:42 AM #9
Troy Erickson AZ Realtor (602) 295-6807
Good Company Real Estate www.ChandlerRealEstate.weebly.com - Chandler, AZ
Your Chandler, Ahwatukee, and East Valley Realtor

John, as always, spot on with your financing info. Caps are certainly very important when it comes to ARMs.

Nov 07, 2014 11:48 AM #10
Joan Whitebook
BHG The Masiello Group - Nashua, NH
Consumer Focused Real Estate Services

John - I always have had questions on when an ARM is appropriate for a give buyer.  This post is most informative.

Nov 07, 2014 12:11 PM #11
Praful Thakkar
LAER Realty Partners - Andover, MA
Andover, MA: Andover Luxury Homes For Sale

John Meussner I suggest my 'condo' buyers to go for ARM - and one good product from a local lending institution is 5/5 ARM! Yep, 5/5!

Nov 07, 2014 12:55 PM #12
John Meussner
Mason-McDuffie Mortgage, Conventional Loans, Jumbo Loans, FHA, 203(k), USDA, VA, - Walnut Creek, CA
#MortgageMadeEasy Walnut Creek, CA 484-680-4852

Dorie Dillard that's great, I love hearing stories about people that used the program the right way!


Beth - thank you for the comment, it's definitely a misunderstood product


Michael - thank you, glad you stopped by to read


Joy Daniels wouldn't have written it without your suggestion, thank you, and thank you even more for sharing.


Bob - HA!  Not those arms, but thank you for the comment & have yourself a great weekend, too.


Debbie - glad to hear you've had the loans work out well for you.  So long as you watch the margins & adjustment dates, it's a pretty easy loan to manage.


Carla - couldn't agree more. When I wrote that part about ARMs being the cause of all the problems, I wish I could've used a sarcasm font - it just seems like ARMs take all the blame from many consumers


Troy - thank you sir, and agreed, caps are an important part that's often overlooked.


Joan - thank you, glad you found it informative & I hope it can help your clients make the right decision in the future


Praful - that sounds like a great product - I wonder how much different the rates are from the 5/1.  That would be a great product to offer.



Nov 07, 2014 01:03 PM #13
Laura Cerrano
Feng Shui Manhattan Long Island - Locust Valley, NY
Certified Feng Shui Expert, Speaker & Researcher

Talk about thorough! And it's also the best use of an acronym on AR and I've seen in months at the same time! Great job!

Nov 07, 2014 03:42 PM #14
Joe Petrowsky
Mortgage Consultant, Right Trac Financial Group, Inc. NMLS # 2709 - Manchester, CT
Your Mortgage Consultant for Life

Good morning John. I don't consider ARM's a dirty word at all, there is a need, but as you well know there is no such thing as one size fits all.

Great job with your post, a well deserved feature.

Make it a great weekend!

Nov 07, 2014 05:52 PM #15
Roger D. Mucci
Shaken...with a Twist 216.633.2092 - Euclid, OH
Lets shake things up at your home today!

And I expected to see photos of you with your shirt off John, flexing your ARM's.  

All kidding aside, great post packed with wonderful information.

Nov 07, 2014 07:52 PM #16
Gita Bantwal
RE/MAX Centre Realtors - Warwick, PA
REALTOR,ABR,CRS,SRES,GRI - Bucks County & Philadel

John, you always provide good information about mortgages. Good advice for consumers.

Nov 07, 2014 08:26 PM #17
Susan Haughton
Long and Foster REALTORS (703) 470-4545 - Alexandria, VA
Susan & Mindy Team...Honesty. Integrity. Results.

Outstanding explanation.  Got a chuckle out of the comparison to one's ex...cute!

Nov 07, 2014 09:14 PM #18
Richie Alan Naggar
people first...then business Ran Right Realty - Riverside, CA
agent & author

Great physically going in because those teaser rates are so low. Mentally however, in the back of your mind, you wait for the letter in the mail that says your payment is going up....

Nov 07, 2014 11:06 PM #19
Maria Gilda Racelis
Home Buyers Realty, LLC-Manchester, Bolton. Vernon,Ellington - Manchester, CT
Home Ownership is w/in Reach. We Make it Happen!

Hi John: Love the title!!!. There are situations when ARM is the best financing option for the buyers. A good loan officer should offer this other than the fixed term when he thinks that the buyers will benefit more from this loan program, Bookmarked this for my future reference. Excellent article.

Nov 07, 2014 11:27 PM #20
John Meussner
Mason-McDuffie Mortgage, Conventional Loans, Jumbo Loans, FHA, 203(k), USDA, VA, - Walnut Creek, CA
#MortgageMadeEasy Walnut Creek, CA 484-680-4852

Laura Cerrano ha glad you made it through, I think this was the longest blog I've written, thank you for reading!


Joe Petrowsky I think anyone that knows what they're talking about knows the value of the ARM in the right situation.  Unfortunately, consumers have been scared away from them.


Roger - HA!  I wouldn't put the AR members through something that traumatizing!  Thanks for the comment.


Gita - thank you, I greatly appreciate thte comment.


Susan - thank you for reading & commenting, glad you enjoyed.


Richie Alan Naggar Author PEARLS SERIES of books I think the more informed someone is, the less scary the product becomes.  Especially those with plans to sell or pay off the loan before the adjustment, there's not much fear to be had.


Maria Gilda Racelis thanks so much for the kind words, and I agree -  it's my job to present all of the options and help my customers find the best one.

Nov 08, 2014 02:08 AM #21
Pamela Seley
West Coast Realty Division - Murrieta, CA
Residential Real Estate Agent serving SW RivCo CA

John Meussner you show you are an expert in your field. ARMs are not for every buyer. Those who bought in '06 with an ARM had no idea the market was going to tank. 10-year ARMs will be adjusting in soon. 

Nov 08, 2014 04:32 AM #22
Kathleen Daniels
KD Realty - 408.972.1822 - San Jose, CA
San Jose Homes for Sale-Probate & Trust Specialist

John, It is nice to know ARMs have changed.  There are so many well-intending people who seem to know everything about real estate and real estate financing. Many of them have never even owned a home. (LOL)!  I spoke to one of those people the other day. My head was spinning like Linda Blair in the Exorcist.  This is why smart people need to hire an expert who not only knows what they are talking about ... they know their jobs and they do them well. An expert like, John Meussner

Nov 08, 2014 10:11 AM #23
Joan Whitebook
BHG The Masiello Group - Nashua, NH
Consumer Focused Real Estate Services

Thanks for this most informative post.  ARMs have always been a type of loan I have not understood. Thanks for the heads up. 

Nov 08, 2014 12:10 PM #24
Laura Filip
Laura Filip Broker , Opening doors for All Seasons of Life - Whitesboro, TX
What can we do for you today?

Very good post feature worthly indeed. Thank you for sharing. have a great day  Points and Arms there is alot to think about when getting a loan. Therefore a good lender is needed to better understand it all. 

Nov 09, 2014 07:21 AM #25
Jon Kolsky
Kolsky Realty & Management - Long Beach, CA
Licensed California Real Estate Broker

John Meussner ~ wow, this is another outstanding post! The lending lingo is confusing and overwhelming for borrowers. I am sure there are "dirty words" getting slung around loosely... And that's why borrowers need a true expert "such as yourself" to break it all down for them... I can't wait to back link this post as it has a lot of "flex" to it,    

Nov 09, 2014 11:25 AM #26
Suzanne Otto
Six Twenty Designs - Lansdale, PA
Your Montgomery County PA home stager

While you certainly explain that ARMs are the good loans now, I just can't wrap my head around the increase! I just play it safe all around. 

Nov 10, 2014 12:05 AM #27
Jeff Jensen
The Federal Savings Bank/Lending in 50 states - Greenwich, CT

ARMs can be effective tools for getting a lower interest rate if you know you won't be living in one place for long.

Nov 10, 2014 07:01 AM #28
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