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CFCU Blog

Blog Series: Spotlight on the Adjustable-Rate Mortgage

by User Not Found | Mar 16, 2018

This article is the first of a two-part series looking at Adjustable Rate Mortgages--and why they might be a better fit than you think. Our expert guest author is Jeff Klein, Assistant Vice President of Mortgage Lending & Real Estate at Congressional Federal Credit Union.


 

Adjustable-rate mortgages are bad, right?  Aren’t they what caused the global meltdown?”  As mortgage professionals, we hear this misconception from members on a daily basis. Over the past decade, you need only have turned on the TV, picked up a newspaper, or visited your favorite news site to learn about the evils of the adjustable rate mortgage (“ARM” in mortgage speak).
  
But after a quick consultation with one of our Mortgage Loan Consultants, many of our members are pleasantly surprised—if not downright shocked—that an ARM could be an optimal solution for their specific needs. Could you be one of those members? Let’s take a deeper look at ARMs and weed through the various myths and realities to answer that question.


30 Year Fixed: The Gold Standard?

 

Let’s start out by reviewing the bedrock product of the mortgage industry.  I’d estimate that at least 80% of members looking for a home loan start out the discussion saying that they’re interested in a 30-year fixed.  After all, who doesn’t want the comfort of knowing that their interest rate will never change, whether it’s year 1 or year 30?  It’s stable and it’s secure. But it’s important to realize that security has a cost, and it’s a cost that is paid by you.
  
No one knows where interest rates will go in the future. So if a lender contractually guarantees you a fixed interest rate for thirty years, they want to receive a hefty premium in return. And they do just that.  The rate on the 30-year fixed will almost always be the highest of any home loan product. 

Whether that security is worth the cost is a question that only you can answer.  But before we even get that far, there’s another important variable we need to consider.  As noted, the added cost you pay for a 30-year fixed stems from the fact that your rate is fixed for the entire 30 years.  But how many of us actually stay in the same house for 30 years?  Furthermore, of those who have found their “forever home,” how many stay in the same mortgage for 30 years without refinancing?  

Certainly in some parts of the country where jobs are more stable, it’s more common to find your dream home and stay there for a long time.  But here in the transient Washington DC area?  Not likely! Many of our members don’t know where they’ll be in three years, much less 30.  Jobs change; administrations turn over; commutes get longer; families grow. In other words, life happens. And if you find yourself paying off your 30-year fixed-rate mortgage a few years later because you’ve sold your house or refinanced, you’ve spent a lot of extra money for a benefit (a fixed rate) that you didn’t ultimately need.

For Your Consideration: The ARM

 

So, is there a better option?  First, let’s be clear about what we’re talking about when we discuss ARMs.  Here at Congressional Federal Credit Union, our adjustable-rate products are what we call “hybrid ARMs.” This simply means that there is an initial period where your rate is fixed, followed by a period where the rate will adjust to the prevailing market rate. 

For example, let’s take the 7/1 ARM . The “7” in 7/1 represents the fixed period and the “1” represents the annual adjustment. So you would have an interest rate that is fixed for the first seven years. Then for each of the remaining 23 years, the rate would annually adjust to the prevailing rate. 

It’s true that when the adjustment period comes around, the prevailing rate could be higher. But it could also be lower.  In fact, many members who took out ARMs over the past seven years have indeed seen their interest rate drop when the adjustment period arrived.  So while they are certainly adjustable rate mortgages, our ARMs really are better thought of as hybrids: part-fixed and part-adjustable, to give you the best of both. 


Our ARM Offerings

 

We currently offer a 3/1, a 5/1, a 7/1, a 10/1, and our newest product offering: a 5/5 (more on that later).  In general, the longer the fixed period, the higher the interest rate.  Remember, with each longer fixed period, the lender is giving you more rate security that comes with a cost. But even the rate on the 10/1, which has the longest fixed period, is still significantly lower than that of the 30 year fixed rate.  As I'm writing this, a quick check of our rates shows a .75% difference between the two. That can mean a significantly lower monthly payment.

But wait.  I know what you’re thinking.
What happens if rates shoot up drastically?
Is there a limit on how high it can go?

The answer is yes.


Every ARM product at our credit union has a series of caps specifying limits on how much the rate can adjust on the first adjustment, any subsequent adjustment, and most importantly, at any point in the life of the loan.  So while you don’t know exactly what the interest rate will be when the rate adjusts, you do know the worst case scenario and can analyze accordingly. 

 

Read Part 2 for a deeper dive with side-by-side comparisons of ARMs and 30-Year-Fixed mortgages.