With fixed mortgage rates still relatively high compared to recent years, and ARMs finally offering a good discount, you may want to start looking beyond the 30-year fixed term.
The problem though is that you may still be worried that interest rates may rise and your ARM will adjust too high in the future.
That’s always a concern with mortgage-rate mortgages, which is why they were lowered in the first place.
But one thing you can do to reduce this risk and manage payments after payment is adjusted is to use a monthly savings ARM for a fixed rate period.
This way you will have a much smaller loan balance when the mortgage reaches its first adjustment.
Use Your ARM Savings to Pay Off Your Loan Faster While Fixed
Let’s look at an example to illustrate what I mean by using a $400,000 loan.
Imagine you can get a 30-year fixed today at 6.5% or a 7-year ARM at 5.375%.
That would be $2,528.27 per month for 30 years fixed compared to $2,239.88 for an ARM.
That’s a difference of $288 per month. Over a fixed period (84 months), you will save approximately $24,225. It’s not bad.
After 84 months, the loan balance will be $361,664.98 for the 30-year fixed and $354,410.53 for the 7-year ARM.
So in addition to paying less each month, you’ll also pay off the ARM faster because more of the payment will go toward the principal because of the lower interest rate.
Those are the advantages of a variable rate mortgage compared to a fixed rate mortgage, but there are also risks.
Which means the interest rate can increase after the fixed rate period ends. And a lot is possible!
Typically, adjustable rate mortgage rates on a 7-year ARM allow the rate to increase by about five percentage points at the first adjustment.
That means a rate of 10.375% in the worst case scenario. That’s almost impossible, but it’s a risk associated with ARM.
Of course, in the meantime you may sell the property, or you may offer a loan if prices improve.
But if you still hold the loan after seven years, you may face a higher rate with a full index (margin + mortgage index in month 85).
This might be a decent rate if the mortgage index isn’t that high at the time, but let’s pretend it’s a little high.
How to Get a Lower Monthly Mortgage Payment After an ARM Adjusts Higher
Say your fully indexed rate is 7% on the first adjustment. Using a balance of $354,410.53 and a remaining loan term of 23 years, the monthly payment would be $2,586.91.
No offense. It’s about $60 more than the original 30-year fixed payment. And it’s seven years old and probably sounds cheap because of inflation.
But what you can do to further reduce this payment, and reduce some risk if the initial repair is too bad, is to use the monthly savings on additional payments.
So over the first seven years, pay an additional $288 per month saved in the ARM.
At the beginning of the eighth year, when the loan begins to adjust, the balance will be just over $325,000.
Now if we use the fully indexed rate of 7%, the payment is less than $2,372.24. That’s about $150 less than the original 30-year fixed payment.
Additionally, a lower loan balance may make it easier to refinance or sell due to a lower loan-to-value (LTV) ratio.
So by paying more using only ARM savings, you’re creating an increased option to do other things if mortgage rates become less attractive in the future.
Try my early mortgage payment calculator to determine potential savings on additional mortgage payments.
