One bold move to pay off your mortgage faster

One bold move to pay off your mortgage faster
The gain may outweigh the risk
Yahoo Homes By Tony Moton
November 7, 2014
A bold move to pay off your mortgage</span>Most homeowners have a love-hate relationship with their mortgage. They love the idea of owning a home but hate spending decades paying it off to finally own it.

If you feel the same way, you might want to consider taking a bold step to pay off your mortgage faster - purchasing an adjustable rate mortgage (ARM).

Though not as popular as the much more common fixed-rate mortgage (FRM), an ARM might be the right choice if you're willing to trade in the long-term stability of steady house payments for the riskier, short-term gain of lower interest rates for a specified period of time.

"I think adjustable-rate mortgages are a financial tool that, if used in the most proper way, will provide people a chance to maximize their money and provide a greater return," says Nicole Rueth, a producing branch manager for Fairway Independent Mortgage in Golden, Colorado. "But if that tool is not understood and used appropriately, it could bite you."

Interested in learning more? Then read on for answers to four key questions about ARMs and why they might be worth the risk for some homebuyers.

Question #1: How does an ARM differ from a FRM?

As the names suggests, ARMs and FRMs differ in how interest rates are applied over the  term of the loan. According to the U.S. Department of Housing and Urban Development (HUD), an ARM is subject to changes in interest rates, and its monthly payments could increase or decrease at intervals determined by the lender.

For example, a borrower can agree to a 5-year ARM - also known as a 5/1-year ARM - which has a fixed interest rate for the first five years. But every year after that, the rate could change annually, according to the Federal Reserve Board's "Consumer Handbook on Adjustable-Rate Mortgages."

[Want to save on your mortgage? Click to compare rates and lenders now.]

On the other hand, an FRM never sees a change in its interest rate, unless you refinance out of it into another loan. So, if you purchase a 30-year FRM with a 5 percent interest rate, your rate and monthly mortgage payment remain the same for entire 360-month span of the loan.

But here's the real hook of an ARM: Interest rates for adjustable mortgages generally start out lower than those of their FRM counterparts. The Federal Reserve Board reports lenders are prone to offer lower interest rates on ARMs, in part, to attract borrowers to the loans.

Notes the Federal Reserve Board: "At first, this makes the ARM easier on your pocketbook than would be a fixed-rate mortgage for the same loan amount. Moreover, your ARM could be less expensive over a long period than a fixed-rate mortgage - for example, if interest rates remain steady or move lower."

Harris Rosenblatt, a senior mortgage banker with Eagle Bank of Potomac, Maryland says borrowers seem to have an aversion to ARMs when they actually might be a better choice than FRMs in plenty of cases.

"People take fixed-rate mortgages out of fear, but the 5-year [ARM] is a better product over time," says Rosenblatt .

Rosenblatt says he bases his pro-ARM stance on his personal observations of the performance of ARMS. He says ARMs mortgages typically don't see drastic rises in interest rates over time, meaning they potentially can be more cost-effective than FRMs during the lifetime of mortgages.

So how do different types of mortgages stack up in terms of interest rates? According to Freddie Mac, the government mortgage loan entity, as of September 25, 2014, the average interest rate for a 30-year FRM was 4.2 percent (and 3.36 percent for a 15-year FRM). By comparison, the average interest rate for a 5/1-year ARM was 3.08 percent and 2.43 percent for a 1-year ARM.

[Shopping for a mortgage? Click to compare rates and lenders now.]

Question #2: How can an ARM help a homeowner pay off debt?

An ARM is a "prudent investment," because it has the potential to enable borrowers to have more cash in hand earlier in the loan, says Rosenblatt. Because interest rates for ARMs are likely to be lower than interest rates for FRMs at the start, Rosenblatt says borrowers save money with adjustable-rate loans.

"[Purchasing an ARM] will allow you to allocate more resources to pay your debts," Rosenblatt says.

Rosenblatt offers this comparison between a 5/1-year ARM and a 30-year FRM on a home loan of $417,000: If the ARM in this case has 2.875 percent interest rate, the monthly payment is $1,730 for the first 60 months of the loan. The FRM, with a 4.25 percent interest rate, has a monthly payment of $2,051.

Over the first five years of the loan, you would save $13,860 by going with an ARM instead of an FRM. You could then apply those savings to higher-yielding investments, says Rueth.

"The reason you get an ARM is so that you can get the lower interest rate today and optimize your cash flow," Rueth says. "What I try to do is educate the borrower to use it as an investment vehicle."

But the danger remains that the interest rate on an ARM will rise after the first fixed-rate period ends, Rosenblatt acknowledges. For that reason, Rosenblatt says, people worry they might suffer from a bad case of sticker shock if their interest rates and monthly payments increase by a substantial amount.

"Your understanding of the product will allow you to have less stress about it," Rosenblatt says.

But if the interest rates do begin to rise, caps on how high they can go provide a measure of comfort to borrowers who might worry about ARMs over the long term, he explains.

[Click to compare mortgage interest rates from lenders now.]

Question #3: What are the risks and drawbacks of an ARM?

The length of time that an ARM's interest rate stays fixed - whether 1, 5, 7, or 10 years, for example - might be likened to a honeymoon period. As long as the interest rate is low and stable, the homeowner certainly can feel good about his or her relationship with the mortgage.

But once the ARM reaches the point where the interest rate could go up or down, panic might set in for the borrower. In the worst-case scenario, according to Rosenblatt, the interest rate that was at 2.875 percent for 5 years could swell to 4.875 percent in its first year of adjustment and go up even more every year thereafter until it hits a cap.

Although there are caps that determine how much an ARM's interest rate can elevate (2 percent annually and 5 percent over the lifetime of the loan), any rise in the interest rate will increase the homeowner's monthly payment.

Rosenblatt says understanding what factors might contribute to an ARM's rise in interest rate could help borrowers better determine whether an adjustable loan is right for them. He points to the London Interbank Offered Rate (LIBOR) as  one of the most common interest rate indexes to make adjustments to ARMs.

"Knowing how the LIBOR works will help people have less fear about what will happen at the end of an ARM term," Rosenblatt says.

The Federal Reserve Board reports that the LIBOR is among a handful of indexes that lenders might use to determine the rise and fall of interest rates on ARMs.

As a suggestion, the Federal Reserve Board says you should ask your lender what index will be used for your ARM, how it has fluctuated in the past, and where the index is published so that you might track its progress, either online or in major newspapers.

[ Ready to buy a home? Click to compare mortgage loans and rates now.]

Question #4: Who should consider an ARM and who should not?

Rosenblatt, who serves the Washington, D.C., area, estimates that about one-fourth of the loans he services are ARMs. The main reason for such a high percentage of adjustable loans, he says, is that people who work in the governmental or political areas tend to be more transient.

"A mortgage in my market lasts only 4.1 years on average," Rosenblatt says. "People sell their homes or refinance into other products."

So, no matter where you live, if you know that you're going to be staying in a home for a set period of time - let's say 5 years -  a 5/1-year ARM might make sense. You could experience the benefit of having a lower interest rate and monthly payments for five years before you sell or refinance the property.

According to John Friedman, an advice-only financial planner based in San Francisco, an ARM might be ideal for people who have contract jobs, military personnel who are used to moving, or those who have a definite time for how long they want to stay in a particular home.

Friedman says, however, "A lot of times, people think they're going to move and they don't. Yes, people with ARMs are paying a lower interest rate than anyone else is paying, but if they are going to live somewhere long-term, I wouldn't suggest they get an ARM."

People who might be uneasy about the potential of fluctuating interest rates might also want to steer clear of ARMS. But Rueth points out that to qualify for ARMs, borrowers are vetted to determine whether they have the financial means to potentially handle higher interest rates should they adjust that way.

In other words, if you purchase an ARM with a 3 percent interest rate, you need to be able to afford payments at a 5 percent interest rate - just in case your rate ever reached the highest cap figure of the interest rate, Rueth says.

Keep in mind that the scenario of your interest rates ever reaching its highest cap figure or going up dramatically seems pretty unlikely if recent trends of the indexes are any indication, according to Friedman. Still, ARMs are not for everyone.

"They are for people who can stomach the fluctuation of the market in the future," Friedman says. "They are not for people who are risk adverse."

Finance
Mortgage Loans
interest rates
Federal Reserve Board
adjustable rate mortgage

Click to view comments View Comments (66)
Share this


Recommended for You
Art and Industry: Responsible Plastic Made from Wool
On the vanguard: A new structural plastic made of sustainable wool and bio-resin. Created by Devon-based designers Justin and Hannah Floyd, Solidwool offers a nontoxic and responsibly manufactured answer to plastic. Here are some ways that Solidwool might make its first appearance in your home.
Remodelista
Save2014 Chevrolet Clearance Don't Pay MSRP of $12,170Massive November Chevrolet Sale Now! Get Our Lowest Chevrolet Price & Save. Check Special Internet Chevrolet Prices Right Now. Hurry, Ends Soon.
AdChoicesCar.comSponsoredBest refrigerators for people who love to entertain
If you do a lot of entertaining at home—hosting for the holidays, throwing backyard barbecues—you want a refrigerator with plenty of storage capacity. Thanks to thinner insulation, slimmed-down ice makers, and other space-saving innovations, most refrigerators these days are pretty roomy inside.…
ConsumerReports.org
SaveRemodelista London Market Spotlight: Kirsten Hecktermann Textiles
After years of creating textiles and costumes for film sets and magazines (including many features in The World of Interiors), London designer/stylist Kirsten Hecktermann launched her own lines of spoons and textiles for the home. The spoons are designed by Kirsten and handcrafted by artisans in…
Remodelista
SaveDurslade Farmhouse in Somerset: The New Bloomsbury?It's an unlikely love story. High-flying, edge-loving Swiss art dealers Iwan Wirth and Manuela Hauser of Hauser & Wirth (they have contemporary art galleries in London, New York City, Zurich, and Los Angeles) fell for the ancient, King Arthur–esque landscape of Somerset, England, a while back, and…
RemodelistaSaveTable of Contents: London Calling
We’re excited to be hosting our first Remodelista London Market this Saturday, November 15, organized in conjunction with The New Craftsmen and held at the collective's exhibition space in Mayfair. In anticipation, we’re devoting this week to our latest favorite UK design discoveries, including a…
Remodelista
SaveThe Remodelista Market Comes to London
Last year, we took our West Coast market concept to NYC; this year, we're thrilled to be heading overseas for our very first international Remodelista Market in London, held in conjunction with The New Craftsmen. Expect to find an exciting array of Brit designers and creatives mixed with a…
Remodelista
SaveTwo-Box Home: Simple Dwelling of Dual Shipping Containers
When executed well, container architecture speaks for itself - the constituent containers become the anchors for the design around which the rest of the materials and spaces flow. This is one such exemplary structure. In the Savannah Project from PriceStreetProjects, two containers are slightly…
Dornob.com
SaveCredit Cards Are Now Offering 0% APR through 2016!Consumers can get rid of high interest rates & receive 0% APR for 18 months for interest free payments until 2016. Other offers include $100 cash.
AdChoicesCompareCards.comSponsoredHow to remove white haze from your good dishes
Soon it’ll be time to get out the good dishes and glassware for holiday entertaining. If you have hard water in your home, chances are your dishware is hazy or covered with a whitish film. If so, don’t despair, there are some dishwasher detergent additives on the market that can make your glasses…
ConsumerReports.org
SaveThe Architect Is In: A Passive Solar House for a Family of Stargazers
This weekend Jennifer Beningfield, founding principal of London's Openstudio Architects and a member of the Remodelista Architect/Designer Directory, talks to us about a passive solar house she designed in the Great Karoo, a semidesert region of South Africa. The Challenge: The area's harsh…
Remodelista
SaveCurrent Obsessions: Across the PondTake a look at a few things we've been noticing lately.
RemodelistaSaveFor Sale: Beach Penthouse With Panoramic Views
Perched above the ocean, the stunning contemporary home boasts impressive water and skyline views from every room.
Zillow
SaveFull Disclosure: Reveal Your Home's Flaws to Speed the Sale
Cracks in the foundation? Leaky roof? If you want to sell your house, it's best to be upfront and address its shortcomings.
Zillow
SaveYou can remodel your kitchen for as little as $5,000
About 1.5 million homeowners will remodel their kitchens this year, spending an average of $19,000 per project. But you can do it for a lot less if you’re willing and able to do most of the work yourself. Figure on spending $5,000 and investing a month of your time. That money will go a long way if…
ConsumerReports.org
SaveProForm Hybrid Trainer - Two Machines in OneThe cardio boost of a recumbent bike paired with the total-body fitness of an elliptical. Order your Hybrid Trainer - pay no interest for 6 months.
AdChoicesProFormSponsoredIs Your Home Ready to Keep You Warm This Winter?
Stay cozy through the chilly months ahead with these seven tips for winterizing your home.
Zillow
SaveHow to keep your old stove going
Cooking season is heating up, but if your range isn’t, try these tips from Consumer Reports' experts. They can help you keep your old—or new—range cooking and even looking good. Of course, if you need a new one before the holidays check out our range Ratings and recommendations.   On the cooktop
ConsumerReports.org
SaveDIY: A Holiday Tablecloth Dyed with Red CabbageI went to my local fabric store and bought several yards of natural cotton fabric for $15. Looking for more ways to DIY your Thanksgiving?
RemodelistaSave3 decades later, 'Nightmare on Elm Street' house is a dream home
Thirty years ago, on Nov. 9, 1984, "A Nightmare on Elm Street" hit theaters -- upsetting the sleep of a generation of viewers. The home has changed little on the outside. But the inside is a far different story.
Spaces
SaveThe blenders that make the best smoothies
Knowing that smoothies and frozen drinks are among the most common blender recipes, Consumer Reports modified its test method to better measure those key competencies. As a result, some models have risen in our blender Ratings, while others saw their scores slip. Paying top dollar will get you top…
ConsumerReports.org
SaveTrending on Gardenista: Garden-to-Table Carousing
The Gardenista team has been getting Thanksgiving and the winter festivities started. Have a look at their DIY wreaths, garages transformed into guest quarters, zero-cost tablescapes, and boozy new use for apple peels. "The secret to making any holiday season look easy is mindful planning," says…
Remodelista
Save3 Companies Poised to Explode When Cable DiesThe "next big thing" in tech is already in your living room, and these three stocks are poised to explode when cable finally dies
AdChoicesThe Motley FoolSponsoredOne bold move to pay off your mortgage faster
Do you hate having your monthly mortgage payments hanging over your head? Then read on to discover one way you could shave years off your mortgage.
Yahoo Homes
SaveLoad more stories
What to read next
The New It Girls: 7 Must-Shop Florists in London
  Architect Visit: South London Mirror House
Sponsored
Gardenista
  Art and Industry: Responsible Plastic Made from Wool
  Best refrigerators for people who love to entertain
  Remodelista London Market Spotlight: Kirsten Hecktermann Textiles
  Robots and technology threaten 10 million UK jobs
Sponsored
CNBC
  Durslade Farmhouse in Somerset: The New Bloomsbury?
  Putin seeks to reassure world amid 'perfect storm'

Sidekick latest slideshow
Photos View 10 Transformative Paint Tricks to Try
  How to Make Affordable Decor Look Expensive
Sponsored
PopSugar Home
  Photos View Photos: Iggy Azalea and Nick Young's new house, bought from Selena Gom …
  Photos View 7 Mistakes Not to Make with your Fireplace
  Photos View 10 Classic Ways to Brighten a Dark Room
  Photos: 'Nightmare on Elm Street' house
Sponsored
Yahoo Homes
  Photos View 10 Quick DIYs to Refresh Your Shower
  Photos View The Pros and Cons of Today's Most Popular Insulation
Yahoo - Zillow Real Estate Network