When interest rates on home mortgages rise, it has a big impact on the mortgage loan market. In late 2014, rates on tradition 40 year mortgages rose from about 3.5% to 4.5% or more. This significant increase had a dramatic effect on monthly mortgage payments for home buyers and made it harder for many borrowers to qualify for home loans. However, there is one type of loan that rates did not increase for and that is an adjustable rate mortgage or ARM. An ARM is typically consider an Arizona home mortgages for bad credit or sub-prime borrowers program, but in the case of rising interest rates it can be a good option for prime borrowers as well.

An adjustable rate mortgage is a mortgage with an interest rate that adjusts after a fixed period. The fixed period is anywhere from 1 to 7 years, with the most common terms being 3 or 5 years. During the initial fixed period, the interest rate on the loan is very low, usually lower than prime. This means that your monthly mortgage payments will be low. After the fixed term, the rate will adjust to a higher interest rate. This will increase your monthly payment amount due to the higher interest payments. When your interest rate does reset, it will be to a higher than prime rate.

Until recently, it only made sense for individuals looking for Arizona mortgages for bad credit to look into adjustable rate mortgages. With traditional mortgage rates low, prime borrowers could easily qualify for and afford the home they needed with a 30 year fixed rate. However, once interest rates rose, monthly payment amounts increased by hundreds of dollars each month and many borrowers were unable to qualify for the loan amount they needed. As a result, many prime borrowers benefited from an adjustable rate mortgage.

The benefits of an adjustable rate mortgage for both prime and sub-prime borrowers are easy to see. When the interest rate on a traditional mortgage is high, the payments on an ARM can be much lower. For example, if you were to qualify for an adjustable rate mortgage with a rate of 3% (current rates are between 2.5 and 3.1%) with a $200,000 purchase price, your monthly payment would be roughly $850 a month. If traditional rates were at 4%, that would increase your monthly payment to over $950 a month (for principal and interest only). If you were unable to qualify for that monthly payment, you would need to look for a cheaper home. In fact, to get a payment equivalent to $850 a month, you would need to decrease your budget by almost $25,000. In some instances that may mean you would be unable to buy the home you want in the neighborhood you want to live in. For many bad credit borrowers, and adjustable rate mortgage is an ideal Arizona home mortgages for bad credit program because it allows them to qualify for a more expensive house with lower monthly payments.

The main risk with ARMs is that the interest rate is subject to change throughout the life of the loan. The interest rate is locked for only a fixed amount of time. After that it will reset annually and your monthly payment will go up. In some cases it can even skyrocket. The increase in monthly payments combined with plummeting real estate values is part of what caused the housing collapse in the mid-2000s.

Before you consider an ARM, make sure you understand the terms of your loan and what that may mean for your payments in the future. Look at the annual interest increases as well as the possible increases for the life of the loan. The short term interest rates for ARMs are still low but there is a possibility they will increase. Make sure to look at realistic scenarios for how your rate may or may not increase and what effect that will have on your monthly payment. One of the main problems with ARMs is that some borrowers may overextend themselves and not be able to afford their home once the rate resets. One of the best ways to examine all of the possibilities is to talk with a licensed broker who can help you work out the numbers and decide if an ARM is the right option for you.

Dennis Dahlberg
Broker/RI/CEO/MLO