Here’s our save more topic for today: When and why an adjustable rate mortgage could save you thousands of dollars. Adjustable rate mortgages or “ARMs” got a bad rap during the real estate bubble years, because so many people signed up for them not realizing that if their interest rate adjusted upward they would no longer be able to afford their monthly payments.
But here’s the key: the initial interest rate on an ARM is lower than that of a fixed rate mortgage, so you can save big money if you know you are going to sell before your ARM adjusts. Maybe you know your job will be transferring you or that you’ll want to move to a better school district or bigger house. There are lots of reasons people plan, in advance to move and THAT is when an ARM can be a bonanza.
First some background: Most ARMs start at one interest rate and then adjust to another interest rate after a set period of time. When you see an adjustable rate mortgage described as a “7/1 ARM,” the first number means the interest rate is fixed for 7 years and the second number means that it adjusts every year after that. The most common ARMs are the 3/1 ARM, 5/1 ARM, 7/1 ARM and 10/1 ARM. Again, the introductory rate for those 3, 5, 7 or 10 years is lower than that of fixed rate mortgages.
Here’s an example of how well it can work: When I was at GMA, I did a savings makeover on a New Jersey family named the Shoblocks. Money was tight because the wife had quite her job and gone back to school in her 50s and the husband had lost his job in the recession. They needed some wiggle room in their monthly mortgage payment AND were hoping to save some money over the long term too.
When the Shoblocks told me they were planning to downsize into a smaller home when their teenagekids went to college, I saw my opening! They were planning to move in the next three to four years. So I found them a 10/1 adjustable rate mortgage, to give them plenty of cushion if they decided to stay a bit longer. Remember, with a 10/1 ARM, the interest rate is fixed for 10 years and THEN begins to adjust.
Their old fixed rate mortgage rate was 6.85 percent. The 10-year introductory rate on their new adjustable mortgage was just 4.75 percent. That new, lower rate saved them a nice $429 a month, loosening their tight purse strings. AND, even better, if they stayed in the house the full 10 years, it would save them $55,203 over that time! So don’t write off adjustable rate mortgages. Think about whether you know you will be moving out at a certain point. Leave yourself plenty of time cushion, just as I did for the Shoblock’s. And then, see what kind of introductory rate you can get! It’s not often that you can take such a simple step that saves you five figures!