How to know when an ‘arm’ is right for you, plus misconceptions people have about this type of mortgage

Adjustable-rate mortgages caused a lot of mayhem during the most recent housing crisis. But the ARMs of today are NOT what they used to be - and it's important to understand the difference. In this video, Brent takes you through what's changed in the last decade, plus all the scenarios in which an ARM might be right (or wrong!) for your unique circumstances.

More of a reader? Catch the video transcript below!

Today, we’re talking about why adjustable-rate mortgages (ARMs) are NOT a product of the past, what kind of ARMs are available, what the different terms mean, and when it would be a good idea to use an ARM vs. a fixed-rate mortgage.

Are ARMs different now than they used to be?

Let’s go back to the last mortgage meltdown. Adjustable-rate mortgages became synonymous with people who were unable to afford fixed-rate mortgages.

The buyer could get a low rate in the beginning, allowing them to afford their mortgage payment each month; until rates spiked, that is. With higher rates came higher mortgage payments that some homeowners were unable to afford, which led to foreclosures.

Because of this, there’s been a stigma in people’s minds around ARMs. But are they really a bad idea in all cases?

Is an adjustable-rate mortgage a good idea in 2022?

When the Dodd-Frank Act was passed in 2010, it made sweeping changes to the mortgage and real estate landscape. It created new rules around what lenders could do with adjustable-rate mortgages by putting caps on how much rates could adjust in a given time period.

Another change in the ARMs of today is that lenders are qualifying borrowers based on the highest potential interest rate instead of the initial loan payment.

Now, there are protections in place that make ARMs less risky today than they were in the past.

What are the different types of adjustable-rate mortgages?

There are four main types of ARM products:

1. 2/1 ARMs

2. 5/1 ARMs

3. 7/1 ARMs

4. 10/1 ARMs

Let’s dive a little deeper into what these numbers mean.

The 2/1 ARM

This is essentially a 30-year fixed product with two adjustments at the very beginning.

Let’s say rates today are 5.5%. So, in year one, the rate would be 3.5%. In year two, it would be 4.5%. Then, in years 3-20, it would jump to 5.5% and stay at that rate.

This would be a good product for someone who knows they will have more income in the future: they’re getting married, getting a raise, bringing in a roommate, or something else in the future that would allow them to make a higher payment after the first few years.

Also, if you know you can make the payment at 5.5%, those few years are just an opportunity for you to save money or pay more toward the principal of your loan.

The 5/1 ARM

A 5/1 ARM is an adjustable-rate mortgage that’s fixed for five years and then adjusts every year after that for the remainder of the loan term.

Related: a 5/6 ARM is fixed for the first five years like the 5/1 ARM, but instead of the rate adjusting every year, it adjusts every six months for the remainder of the term.

The 7/1 ARM

For a 7/1 ARM, you get a fixed rate for the first seven years and then your rate adjusts every year after for the rest of the term.

The 10/1 ARM

You can guess what this product is: the borrower gets a fixed rate for the first ten years of the loan and then the rate adjusts every year after that.

I’m sure there are other ARM products that I’m not mentioning today, so get with your lending professional to see what your options are!

Is an adjustable-rate mortgage right for you?

So, you may be wondering, should I get an ARM or a fixed-rate mortgage? Consider your unique situation and the ARM products I mentioned above.

Think about how long you plan on being in this home. Most people don’t stay in the same home for ten years. Say you know you’ll be in your new home for ten years tops. In this case, a 10/1 ARM might be financially beneficial for you. There’s no point in paying a higher rate for a 30-year fixed mortgage if you’re going to be gone after eight years!

Even if you stay in your home for longer, remember that there are adjustment caps on ARMs. They can only go up a minimal amount in any given year, and they typically can’t exceed more than 5% on top of your initial loan.

The point is, there are parameters in place to keep the ARMs of today from getting out of hand, even when you get into your adjustable period.

On the other hand, an ARM might not be a good idea for someone whose income is a little more sporadic. If you plan to be in your home for longer than your fixed period and don’t expect your income level to rise to meet that higher rate, you probably shouldn’t choose an ARM.

Pro Tip of the Day

The main point I want to get across to you today is that ARMs today don’t carry the same risks as ARMs of the past.

Every situation is unique. If your rate for a fixed mortgage is the same as your rate for an ARM, go with the fixed.

But, if you have some certainty that you’re only going to be your home for a limited period of time, an ARM could make more sense to you.

So, make sure you get with your lender and your real estate agent to structure a deal that works best for you.

That’ll be it for me today, guys - thanks for being here and I’ll see you in the next one!

Brent Edwards (aka Brent the Broker) is a residential real estate agent and Realtor in San Diego, CA who helps clients buy and sell homes in San Diego, California and all surrounding areas. Brent is a highly-recommended Realtor in San Diego by family, friends and past clients. Call Brent today at 619-550-8070 if you have any questions about real estate in San Diego or you'd like to buy or sell a home.