With the rise in mortgage interest rates, more and more consumers are looking for ways to bring affordability back into the home-buying picture. One product to consider is ARM loans, or Adjustable Rate Mortgages. These were very popular before the market crash of 2008, but have gotten a bad rap since then, due to the nature of fluctuating interest rates.
Adjustable Rate Mortgages use a different method for determining the interest rate than conventional loans. Specifically, they are tied to one of three major indexes. The 1-yr T-Bill, the Cost of Funds Index, or the Secured Overnight Finance Rate. The calculation of that interest rate would look something like this:
ARM loans typically have a fixed rate period, anywhere from 3 years to 10 years depending on the product you choose. So for borrowers who only plan to live in the home for, say 7 years, then an ARM loan offers some options that are worth considering.
Here is a comparison of typical conventional mortgage payment and an ARM payment:
In this scenario, the conventional loan would have a fixed principal and interest payment for 30 years. However, the ARM loan would have a fixed payment for the first 7 years, then change, up or down depending on the performance of the index it is tied to, every 1- year after that.
Now, ARM loans aren’t for everyone. But for borrowers planning to stay in their home for only a short amount of time, it can be a great way to purchase or even refinance a home at a more affordable rate.
SOFR index of 2.25% + set margin of 2.50% = fully indexed rate of 4.75%
$500,000 loan amount
- Conventional rate of 5.875%
- Principal/interest = $2,958 per month
- 7/1 ARM rate of 4.75%
- Principal/interest = $2,608 per month (a savings of $350 a month)