Interest Rate Ups & Downs and How to Use an ARM Loan

Working in a real estate firm offers a lot of perspective. It also offers a lot of info I normally wouldn’t be looped into. Every week, we get an update by our financial friend, Drew. Today’s blog post is a two-part to discuss current interest rate trends and the advantages of ARM loans when used correctly. So if you’re like me and you find this topic interesting, have a read!

Wednesday Wire with Drew

Part 1 – A few weeks ago, interest rates soared back up into the high 6’s to almost 7% and now they are back down into the low 6.125% range.  In a 30-day time frame we have seen additional concerns over the banking sector along with a multitude of economic reports showing weaker trends which have driven rates back down.  The latest data comes from last Friday’s Jobs Report and this morning’s ISM Services (non-manufacturing jobs) data.  All of this lean in high favor of the March FED rate hike being the last of what has been a long cycle of hikes. We are of course awaiting next week’s CPI report which as always, is the strongest indicator for inflation, should it point in the same direction we will have reached the culmination of hikes hopefully.  Remember that we would then be in a long-term holding position as the inflation continues to dwindle downward.  We would be able to expect rates remaining in the low to mid-6 range for the duration of 2023.

Part 2 – ARM Loans (Adjustable Rate Mortgages), in order to understand the advantages of an ARM loan we need to understand what it is and how it works.  ARM loans are a mortgage with an interest rate that adjusts over time based on the market, essentially a variable rate.  It is important to keep in mind that ARM rates are generally lower than fixed rates.  The initial interest rate of an ARM is fixed for a period of time.  In a 3/1 ARM the rate is locked for 3 years and cannot change during that time frame.  The 1 in that scenario indicates how often the rate can (and will) change after the 3-year locked rate.  Meaning that it can only change once per year every year after which always falls on the anniversary date of your first payment.  The amount of adjustment will depend on the type of ARM you are in and can adjust both higher or lower, but are always designed with the ability to be able to increase more than they decrease.  The basis for the increase/decrease is dependent on the market vs your interest rate.  Simply put, if the market rate is higher than your rate than yours can go up, and vice versa.  The best analogy I can give is that an ARM loan is like going to Las Vegas, it is a gamble that can win if played correctly, but you never want to play to long because you will eventually wind up losing.  The term “The House always wins” comes to mind.

This brings us to why would you ever use an ARM loan if ultimately your rate will go up?  In my opinion as a Mortgage Lender, there are only two reasons to consider an ARM loan and both have the distinct advantage of saving you money but also the very important parameter of not remaining in that ARM past a certain point.  Reason One – short term financing due to length of time you will be living in a house.  The use of an ARM for the purchase of a home when you will only be keeping that home for a period of a few years can reap the advantage of a lower interest rate, remaining locked, and then selling the home prior to any adjustment period.  This is a popular use of the ARM for example with Vendors who are relocated into an area for work for a 2-year period for instance.  They are then relocated to another area after 2 years and thus selling the home.  Reason Two and probably the most relevant reason given the current state of things would be to purchase a home in a higher rate environment (such as the one we are currently in) and then refinancing a home when interest rates come down.  Looking at today’s interest rates is a perfect example of this – the 30-year Fixed rate is at 6.25% vs a 3/1 ARM rate of 5.375%, on a $340,000 home that places the ARM loan at $200 a month less than the Fixed Rate Mortgage.  In a 2-year time period (2 years used for example because that is the length of time expected for interest rates to come back down) a person would save approximately $6,000 in interest over that 2 years.  This allows them to capitalize on a lower rate and save money prior to refinancing to a fixed low rate within a time period.  Remember the object goal is to always get out of the ARM either by selling the home or refinancing, ideally prior to the first adjustment.

*interest rates may vary dependent on credit score and other factors

Drew Waack NMLS# 1573539