Why You Should Refinance Your Home with a 5- or 7-Year ARM

The 30-year fixed rate mortgage is the most common type of mortgage in America and has been for years. People choose the fixed rate 30-year mortgage because they like the stability of knowing what their payment will be for many years.

But the reality is that few people stay in a home for 30 years anymore. Most people move within five or seven years of buying their home. For people who are only planning to stay in their home for a limited time, you may want to choose a 5- or 7-year adjustable rate mortgage or ARM.

People who have 30-year fixed rate mortgages today may discover they are paying close to 5%. You could save quite a bit if you switch to an ARM.

A 5- or 7-year ARM can lower your expenses each month considerably and give you more options down the road.

But many home buyers often dismiss an ARM as an option. They know that the rate and payment will eventually go up or down after the fixed rate period ends, and that can make some people nervous. That is why 95% of people go for a fixed rate loan.

But a 5- or 7-year ARM can be a reasonable risk for some home owners. It offers a lower rate and several years of fixed rate payments. For many Americans, getting an ARM for 5 or 7 years gives them enough time with fixed rate payments to make the risk worth it. The majority of home owners sell their homes within seven years anyway.

If you are one of those homeowners who do not see yourself in the same home for 20 years, you might want to alter how you shop for a home loan. A 30-year fixed rate loan does lock in your interest rate for many years, but you are paying a higher rate than you would for an ARM. With a 7-year ARM, you could spend a lot less on interest during the time that you actually live in the home.

Key Elements of an ARM

An ARM is a variable rate mortgage that offers a lower interest rate for a fixed period of time. It is at least .3% to .5% lower than the rate for a 30-year fixed rate mortgage. After the fixed rate period ends, the rate can be adjusted based upon the current market. There are six major factors to consider about ARMs:

• Initial interest rate: This is the rate during the fixed rate period.
• Adjustment period: How often the rate will change after the initial fixed rate period.
• Index: A market rate used to determine the new interest rate when the loan adjusts after the fixed rate period.
• Margin: The amount of interest rate points that are added to the index to determine your new rate.
• Interest rate cap: The limit on rate increases during the adjustment period and the total life of the loan.
• Payment cap: The limit on the amount the monthly payment can go up.

At the end of your fixed rate period, the new rate equals the index plus the margin. The index may change but the margin will not. With a seven-year ARM, you would look at the index as you get to the end of the first seven years. If the index is at 3.1% at that time, and the margin is 2.25%, your first adjustment period would start with a rate of 5.35%.

With a five year or seven-year ARM, the rate cannot change during that period. For most homeowners, this time frame will exceed the time they live in the home, especially the seven-year ARM. Even if you do not sell, there still is a solid chance that you will refinance a few years after you buy the home.

If the rate on a five- or seven-year ARM is .5% less than a 30-year fixed rate mortgage, you could save $8000 in interest over seven years on a $250,000 loan, and about $6000 on a five-year ARM.

Even if you decide to stay in the home past five or seven years, the ARM still can work. There is a lifetime cap that is a firewall of sorts on ARMs today. Even if interest rates skyrocket, they can only affect your loan so much.

For example, an ARM that has a rate of 3% in the first five years and a 5% cap for life cannot rise above 8%.

The bottom line is a five year or seven-year ARM should be considered by more home buyers today, especially with fixed rates nearing 5%. Most people do not stay in their home for 30 years, so you can save a lot of interest payments by opting for an ARM.