What about Adjustable Rate Mortgages (ARM’s) in today’s high interest rate environment?

I frequently mention the possibility of Adjustable Rate Mortgages (ARM’s) to my clients.  We haven’t seen them much over the past 15 years but they were once quite prominent and useful.  I’ve had 2 or 3 of them myself in the past.

There are both positive and negative aspects to this kind of mortgage, most notably perhaps, that the interest rates will periodically adjust.  You are usually locked into a set mortgage rate for only a specified period of time, say 5 or 7 years.  After that period expires then the rate will adjust to current market rates and will henceforth adjust annually.  If rates have gone up in that “locked-in” period, then your rate will likely also be adjusted upward.  (Keep in mind that your income has probably also gone up over that period so your ability to pay a higher rate may not make the adjustment upward daunting).  But if interest rates have gone down then your mortgage rate will also go down.  This flexibility gives lenders the ability to offer a lower interest rate at the beginning, possibly qualifying the buyer for a higher approved purchase price, or at least reducing the mortgage payment on the home they would have to pay.

The Federal Reserve has been raising their interest rates which has translated into higher rates for home mortgages as well.  Most people think that once inflation is under control then those rates will start going back down. How far down they go (and how fast) is anyone’s guess but most of the economists that I have heard opine on this subject suggest that it may settle in somewhere between 4-5 percent eventually.  If that happens then the Principal and Interest portion of your mortgage payment will go down the appropriate amount.  Additionally, if rates go down then you might also be able to refinance into a fixed interest rate mortgage when you think the time is right.

But keep this in mind, sitting on the fence is usually not the best option at times like these.  When interest rates begin going down you can probably expect home values to start going up.  The higher interest rates over the past 18 months has kept a lid on demand, but it’s still there waiting to explode.  So a lowering of rates should only serve to take the lid off and we will likely see people rushing back into the market, driving up the values on homes.  That’s why I tell people that NOW is a great time to buy.  Prices are still a bit depressed but once rates start coming back down, we should have a few years of significantly above average appreciation.