Total Cost Analysis and the Dreaded ARM

By Ryan Dosen

 

The adjustable rate mortgage (ARM) has taken its lumps over the past decade. Many of them well-deserved. However, there may be reason to consider taking another look at the ARM. The numbers behind the ARM may make more sense for your real estate and financial goals than you might anticipate.

 

History of the ARM

The ARM earned its less-than-sparkling reputation back in the devastating real estate collapse of the 2000s. During the real estate bubble, tons of people were saddling up for the ride with adjustable rate mortgages and negative amortization mortgages (mortgages that allowed you to avoid paying full principal and interest payments in the beginning by simply tacking the unpaid amounts on to the end of the mortgage—increasing your balance over time).

The goal was to pay as little as possible out of your pocket in the beginning stages of loan payback. You weren’t going to hold on to the mortgage for 30 years. You were just taking advantage of a hot market. You’d pay 4 percent interest for a couple of years, while allowing the property values to increase by 20 percent. You’d sell relatively quickly, take a fast and easy profit, and be long gone before the rates would ever change. Or so you thought….

The low initial payments also allowed you to qualify for more house and bigger loans than normal. After all, your loan qualifications had been based upon the initial payments, not the payments you could be forced to make a few years down the road after the rates were recalculated.

Of course, we all know what happened. Home prices stopped going up. In fact, they went down. People couldn’t sell and were locked into loans with payments that they couldn’t really afford, even at the introductory teaser rates (let alone the higher, soon-to-be-adjusted rates). Foreclosures ensued. Bankruptcies. Recession. Pain.

And that is how the ARM became that un-dateable person you remember from high school. Under different circumstances, it might have worked. But for whatever reason, it just wasn’t going to happen. Even if there was an attraction. Your friends just wouldn’t allow it. Better to just look elsewhere, even if it meant not getting what you wanted (or what might actually have suited you quite well).

 

Total Cost Analysis of the Adjustable Rate Mortgage

Joe Gonzalez, a local mortgage expert from Gateway Funding in Plymouth Meeting, PA, was kind enough to spend a few minutes with me to compare the numbers behind a typical fixed-rate mortgage and a typical ARM. For the purposes of our discussion, we considered a hypothetical $460,000 fixed-rate jumbo mortgage (jumbo loans are loans that exceed Fannie Mae and Freddie Mac’s maximum loan amount of $417,000) and a $460,000 7/1 ARM jumbo mortgage. A 7/1 ARM has a fixed rate for the first 7 years that can change thereafter based upon a rate index.

Gonzalez cautioned me that actual rates can vary based upon a person’s individual financial situation and credit history. Currently, rates for fixed jumbos are in the mid-to-low 4 percent range, while 7/1 ARMs are in the mid-to-low 3 percent range. For comparison’s sake, we’ll use 4.25 percent for the fixed and 3.25 percent for the ARM.

For the first 7 year of these loans, the numbers significantly favor the ARM. During those first 7 years, the fixed mortgage could require $21,922 or more in higher principal and interest payments. And despite the significantly lower payments during that period, the ARM’s lower interest payments could also result in you paying off something like $9,200 more in principal.

Paying more in interest does generate a tax deduction benefit, which would be worth several thousand dollars to the fixed side. However, after 7 years, choosing the ARM over the fixed mortgage would probably result in something like a $23,980 net savings. On the other hand, if you decided to go with the ARM while keeping the same (higher) monthly payment you would have had with the fixed mortgage, by month 84 you will have paid off an additional $33,000 in principal!

When you learn that Keller Williams Real Estate’s numbers say that the average homeowner sells and moves again after 7 years, the ARM doesn’t seem like such a bad deal after all. If you think you are likely going to move within 7 or fewer years, a similar ARM may actually fit you perfectly.

Of course, the only way to get the actual, hard numbers that will apply to you is to sit down with someone like Joe who can paint your entire mortgage picture. If you’re in the market for a home, don’t automatically dismiss the ARM. Get a professional to explain the pros and cons so that you are fully informed when making your decision.

 

Labor Day

Labor Day is a chance to celebrate the strengths and contributions of this country’s various labor organizations. My mother, Debbie Dosen, is a member of a very important and strong labor union. She teaches reading and learning disabled children at Pine Ridge Middle School in Naples, Florida. Her students made amazing gains this past year and she was just named Collier County’s #1 reading teacher for 2014.

We also have many fine teachers in Chester County and this allows our children to learn in some of the top school districts in the entire state of Pennsylvania. As a father of two with another on the way, I salute and thank them for all the amazing work they do preparing our children for their futures.

 

— Ryan Dosen manages The Wayne Megill Real Estate Team of Keller Williams Brandywine Valley in West Chester. Contact Ryan for buyer or seller representation or for more perspective on the local and national real estate market by emailing rdosen@megillhomes.com or calling 610-399-0338. Please also visit The Wayne Megill Team blog at www.PAHomesAndRealEstate.com.