With the avg cost of homes in the greater Milwaukee area currently at $300,000, 2022 predictions of interest rates for fixed loans increasing to 3.5%-4% and home values continuing growth between 3%-16%; as a new home buyer it can feel like the cost of a home is an arm and a leg. First-time buyers may be feeling priced out of the market. What can you do to get into a home at a more affordable option right now? Have you considered an ARM loan or known as an adjustable rate mortgage loan? An ARM loan is a mortgage loan option where the interest rate can fluctuate, however, there is an initial time period where the interest rate is fixed before it begins to fluctuate. The loan is still typically amortized over a 30 year period, same as a 30 yr fixed loan, so payments will be calculated the same with the key difference that the interest rate is subject to change after the fixed time limit of the loan expires.
For example, a 5/1 ARM loan, means the interest rate is fixed for the first 5 years then after the 5th year the interest rate will be adjusted every year after that based on current market rates and possibly additional percentage by the lender. Currently, in the local Milwaukee area, some lenders are offering a 5/1 ARM at 2.375%. However, there are typically caps to how much the lender can increase the rate annually and as well as a cap on the max that interest rate can ever be over the initial rate. Each lender will set its own terms and limits, but for example, it could be an annual interest rate cap of 2.5% and then a max cap of never more than 7% over the original rate. So worst case scenario, if a buyer stays in the home over the fixed-rate period, they’re able to calculate what the potential max payments every year after that would be and if they can cover that.
Why would a homebuyer decide to use an ARM loan over a fixed interest rate loan? The immediate advantage is getting into a home at a lower interest rate than what’s being offered by fixed interest loans, currently fixed 30 yr rates are around 3.25% vs 2.375% with an ARM as mentioned above. A lower interest rate translates to lower payments as well as more purchasing power meaning a buyer’s ability to buy a bigger home or in a more ideal location vs going with a fixed loan and settling for less. The obvious disadvantage is that after the initial fixed interest rate period, there is some uncertainty on where your interest rate will be when it comes time to adjust your rate. However, keep in mind that there is a max annual cap on the increase. So in the worst-case scenario, you know what your max payments will be increased to. This leads to the final question, is an ARM loan right for you? If you are in similar situations like the ones below, an ARM loan might make sense for you.
- You’re buying a starter home, not a forever home. Some first time home buyers realize that they can’t afford their forever home right away with their current finances or perhaps their family will still be growing but they need somthing now. So they know going into this purchase, that they don’t plan to live in that home for more than 5 years. It’s only a temporary home and they will plan on getting a bigger and better home in the near future.
- You have plans in your personal life to relocate in the next 3-5 years. Or you’re in a job that you know will be relocating you in 3-5 years. This allows you to have a home of your own at lower payments than a fixed loan. Then you sell that home before your fixed interest rate period expires.
- A buyer that knows in 3-5 years their income will increase either through promotions or a spouse graduating college and starting a career. If they stay beyond the fixed interest rate period, they will have the extra income to cover the increased mortgage payments. Or they can choose to sell, upgrade, or refinance out of the ARM loan and into a fixed mortgage loan if they intend to stay long term.
In closing, an ARM loan can be advantageous for a home buyer if their situation fits it. Note that lenders offer ARM loans at all different fixed rate periods from 3-10 yrs. Typically the lowest rates will come with the shortest loan periods. Also, one thing to watch out for is an early payment penalty, meaning if you were to sell your home or refi out of the ARM loan too soon, say only 1-2 years in, the lender will charge you a penalty fee. So it’s best to shop around and find the best rate and terms that work for you. Happy house hunting, if you have any questions on this topic or any other real estate related needs, please reach out to me. I’m available to help any home buyers, sellers, or investors in the greater Milwaukee area.
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