Don’t Waive Your ARMS | Or Your Buy-Downs

If you’re house-hunting in today’s DC real estate market,  you’ll want to think about chucking the traditional 30 year conventional mortgage in favor of a rate-dampening option like the 5/1 ARM. Adjustable-rate mortgages, also known as variable rate mortgages, typically offer rates a full percentage point or more below 30 year fixed rates, lowering your monthly payments while increasing your purchasing power. Here’s how it works:

Adjustable-rate mortgages carry a lower interest rate for a fixed term, then lock in at market rate at the end of that term. This type of loan can be a smart choice for borrowers who plan to keep the loan or the property for a limited time, or plan to refinance, expecting that rates will drop significantly within the loan term. You’ll want to plan for potential interest rate and payment increases, and make sure you have the cash on hand to refinance when the time comes.

There are various types of ARM loans. Another one is the Flexible ARM, or “Option ARM,” which allows the borrower several options as to which type of payment to make each month:

  • 30-year, fully amortizing payment
  • 15-year, fully amortizing payment
  • interest-only “minimum payment”

With this type of loan, it’s important to monitor the debt you owe against the home’s value to make sure you stay in a positive equity position. That requires frequent assessment of your home’s real market value by an expert. These loans are not for the inexperienced. They contributed significantly to the mortgage crisis of 2008.

Be sure to read our Tools page on Adjustable Rate Mortgages for more details, and consult an experienced, local loan officer for terms.

The Buy Down Loan Option

Another loan program popular when rates rise is the Buy Down. The 3/1 Buy Down, for instance,  allows home buyers to pay a lower interest rate now, a pre-determined higher rate the second year and final rate at the third year mark and beyond:

  • Interest rate is reduced by 3% the first year,
  • Interest rate is reduced by 2% the second year
  • Interest rate is reduced by 1% the third year +

When the loan finally resets to its permanent interest rate, borrowers know what their payments will be for the life of the loan, as opposed to the ARM, which adjust to whatever the market rate is when the loan term ends. A fixed-rate 3-2-1 buy-down mortgage is less risky than an ARM for that reason.

The Buy-down program is offered in various terms, such as 2/1, 3/1 and 5/1. It’s an effective hedge against higher mortgage interest rates for borrowers who want to purchase a home while prices are favorable, increase buying power, and ease into payments.  It’s favored by those who expect rates to fall significantly during the buy-down term, their equity to build well during that time, and to have the cash to refinance when that occurs–or for borrowers for whom an income increase is assured during the buy-down term.

A 2/1 buy-down is available on fixed-rate Federal Housing Administration (FHA) loans for new mortgages. The cost of this may be high, though, since FHA loans carry Mortgage Insurance Premiums (MIP) for the life of the loan. This may not be the best short term option unless low downpayment is a primary concern.

Do The Math

Keep in mind that specialty programs carry fees such as loan discount points, as well as refinancing costs, which run approximately 2% to 5% of the loan principal amount in closing costs, according to bankrate.com.

Current Mortgage Interest Rates

Mortgage rates improved slightly last week, nudging below 7%, even after the Federal Reserve aggressively raised its benchmark interest rate again. This is a reminder that mortgage interest rates don’t necessarily follow Fed rates. Key players in the mortgage industry do monitor Fed rates closely, and their interpretation of the Fed’s actions does affect mortgage rates. In this case, the mortgage industry had already priced in the increase. So, following the latest Fed hike, the 30-year fixed-rate mortgage averaged 6.95%, after hitting a 20-year high of 7.08% the previous week, according to Freddie Mac.

“Even with the Federal Reserve raising its short-term fed funds rate by another large amount, longer-term interest rates look to move only slightly. The mortgage market has already priced in the latest Fed move.” 

–National Association of REALTORS® Chief Economist Lawrence Yun

Last Wednesday, the Fed approved its fourth consecutive rate hike of three-quarters of a percentage point in an effort to curb 40-year high inflation. Central bank’s lending rate is now within the target range of 3.75% to 4%, its highest since January 2008.

error: This content is copyrighted and protected