A 10-year ARM can reduce your payment by $624 per month
on an $800,000 loan.
By Jeff Lazerson | email@example.com | MortgageGrader.com | September 1, 2022
* Article originally posted in Orange County Register on September 1, 2022
More than 12% of borrowers applied for adjustable-rate-mortgages in June and July, the highest percentages since August 2007, according to a new Zillow analysis.
And borrowers using ARMs are likely to be affluent households with larger down payments.
Data from last year shows the median income of a borrower receiving an ARM was $165,000 compared with $91,000 for all borrowers, Zillow figures show. And the typical ARM borrower put down 23.6%, while the typical overall borrower put 10% down.
Given this, it’s likely today’s typical ARM borrower would be able to withstand increased monthly mortgage payments if rates rise, the analysis concluded.
It’s all about closing that gap of higher home prices, soaring fixed rates (this week the Freddie fixed jumped to 5.66%, almost double one year ago) and trying to find a house payment you won’t choke on.
I tend to see big mortgage rate spreads between ARMs and fixed rates, making ARMs worth considering when the loan balance is above $647,200. These better rates tend to come from bank depository funds and credit union depository funds, also known as portfolio ARMs.
Take for example a borrower with good credit buying a $1million home with 20% down. Fannie Mae’s fixed-rate for 30-year loan of $800,000 is 5.875% with roughly a 1-point cost. The principal and interest payment would be $4,732 per month.
The rate for a 10-year portfolio ARM is 4.615% with a one-point cost. That payment would be $4,108, saving a whopping $624 per month and $74,880 over 10 years.
Rates are locked during the introductory period, which can be for three, five, seven or 10 years. So, the tradeoff for a significantly lower house payment is the risk of rates adjusting upward after the introductory period ends. Rates can go up, go down or stay the same, based on an index (typically the secured overnight financing rate, or SOFR) plus a profit margin.
ARMs also have a “life cap,” or a maximum rate hike over the life of the loan.
Mortgage servicers using the SOFR index calculate a new interest rate every six months, amortizing the remaining balance over the remaining number of months left on the loan. (The previous vintage of COFI ARMs tended to have annual adjustments.)
Say you took out a 30-year, $600,000 ARM five years ago with a five-year introductory rate. Your initial rate was 4% and your principal and interest payments were $2,864 a month. Your remaining balance is $543,747.
Today’s 30-day SOFR index is 2.284%. Adding in an assumed profit margin of 2.75% brings your new rate to 5.034%. Your new payment jumps by $325 to $3,189 a month because the new rate jumped by more than 1%.
Most adjustable-rate mortgages require the initial principal and interest payment to be based on a 30-year term. There also are 40-year adjustable-rate mortgages, which come with interest-only payments for the first 10 years.
Interest-only rates also are available for three, five, seven and 10-year terms. This means you’d be required to pay just the interest for the introductory period, and your loan balance remains unchanged.
For a 10-year, $800,000 ARM, the rate would be 5.5% and the interest-only payment would be $3,667 a month. That’s $441 less than the $4,108 payment on a 10-year amortizing ARM, which covers both interest and a small portion of the loan balance.
Qualification requirements are much tougher for interest-only loans.
The key factors to look at when considering an ARM are the points and costs, the initial rate, the introductory period, the index used, the profit margin and the life cap.
Freddie Mac rate news: The 30-year fixed rate averaged 5.66%, 11 basis points higher than last week. The 15-year fixed rate averaged 4.98%, 13 basis points higher than last week.
The Mortgage Bankers Association reported a 3.7% mortgage application decrease from the previous week’s 22-year low.
Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $647,200 loan, last year’s payment was $1,057 less than this week’s payment of $3,740.
What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages without points: A 30-year FHA at 5.25%, a 15-year conventional at 5.25%, a 30-year conventional at 5.75%, a 15-year conventional high-balance ($647,201 to $970,800) at 5.625%, a 30-year conventional high-balance at 6.125% and a 30-year purchase jumbo at 5.5%.
Eye catcher loan of the week: A 30-year jumbo mortgage locked at 5.25%, interest-only for the first five years without points.
Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or firstname.lastname@example.org. His website is www.mortgagegrader.com.
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Jeff Lazerson - Mortgage Columnist since 2011