The low rate environment has some borrowers asking JMAC Lending Inc’s brokers if it would be beneficial to obtain an adjustable rate mortgage (ARM). Some believe that by the time the interest increases, they will either be in a higher income bracket or can refinance to a fixed rate. While income growth is expected over time, our experienced brokers tell them that the rise in income has to increase in proportion to the rise in interest in order for an ARM to be affordable.
For example, a $400,000 mortgage with a 2.75% rate on a 5/1 ARM, where rate and payment are fixed for five years then can adjust every year, the initial monthly payment would be $1,630 a month. For someone making $4,650 per month, the monthly mortgage payment would be 35% of the gross income. After five years, the remaining balance on the loan would be $356,000 and the rate can reach a maximum of 7.75%, which would be a monthly payment of $2,670 per month, a 64% increase over five years, or 12% per year. This would mean a monthly income of $7,630 would be necessary to maintain a payment of 35% of gross income.
Similarly, a $400,000 loan with a fixed rate and monthly payment of $1,820 per month would equal 39% of adjusted gross income and would remain the same throughout the life of the loan.
Secondly, brokers will often tell the borrower that refinancing an ARM is possible, but any refinance will likely result in a higher rate leading to a greater monthly payment. The ARM rate is always lower than the fixed rate, so any refinanced rate will be greater than the initial interest rate. More often than not, JMAC’s brokers see that an ARM does not make financing a home more affordable in the long run and ARM’s should be used if financing a less expensive home in order to ensure its affordability.