Most residential loans in the past have been fixed-rate loans with short terms. Before the Great Depression of 1920s and 30s, many of these loans were balloon programs, often with high rates. This was necessary because the mechanism that ARM loan adjustments depend on, a reliable index, had not been widely available. The residential ARM loan was first introduced into the national market as the Variable Rate loan. This term still remains in use with credit cards and installment loans, but it has been replaced in the mortgage industry with the more specific and catchy “ARM” description.
When the variable rate mortgage loan first appeared, it was overly restrictive on the lender. So much so that many of them lost money on it. That was good news for borrowers in the short term; but it was bad news in the long term, as lenders and investors threatened to abandon these programs. In the past three decades, the variable rate mortgage was renamed and further redeveloped, as well as diversified, into today’s ARM loan. Most home buyers still have a natural aversion to ARM loans. Older homeowners who remember the 19% interest rate of the 1970s, are especially leary of the inherent risks of ARM programs. However, ARM loans do have their advantages, which make them ideal for people who can see the home or property purchase as a financial investment.
First of all, if you are only keeping the home for three years or less, you will save money by selecting an ARM loan, instead of a fixed-rate loan. Even if you decide to stay past the third year, many ARMs have a conversion option and some lenders provide no-lender-cost refinances. With the development of 3/1, 5/1 and 7/1 ARMs, which will be discussed in more detail below, ARM programs ffer an even greater opportunity for homebuyers planning on up to a seven-year ownership period with any one property.
When compared side-by-side, the typical borrower will still save more money with the 1-Year ARM (compared with the fixed-rate) for the first three years. After the third year, depending on how the market reacts, the fixedrate or balloon loans are generally better. The reason for the ARM loan’s advantage is that even with any wild increases in the market’s current interest rates, the rate increase caps—or limits—means that monthly payments normally remain lower with the ARM loan for at least two years.
Secondly, ARM loans are the program of choice during periods of high interest rates. History has shown that interest rate fluctuations are normal and tend to be cyclical. During times of comparatively higher rates, borrowers can elect to go with an ARM loan that has a much lower interest rate than theregular 30-year fixedrate. When the market finally improves to lower rates, the borrower can refinance his or her loan. Even if you plan to keep your newly found property forever, if you find yourself searching for a mortgage loan during a period of relatively higher interest rates, go with the lower teaser rate of the ARM loan. Then, once interest rates have decreased, just refinance the mortgage loan to a lower rate—preferably a fixed-rate program. Many times, your current lender will give you a free refinance, just so they can keep you as a borrower.