Why Some California Home Buyers Choose the ARM Loan Option

Home buyers in California have a lot of different options when it comes to their mortgage financing. One of those choices has to do with the rate structure associated with the loan.

For instance, California home buyers can choose between an adjustable-rate mortgage (ARM) loan, or one that has a fixed rate over the life of the loan. There are pros and cons to all of these choices. So you’ll need to do some thorough research to identify the best financing option for your situation.

In this article, we will explore the reasons why some home buyers in California use adjustable-rate mortgage loans when buying a house.

Top 10 Things to Know About ARM Loans

We’re going to take a deep dive into the world of ARM loans, to help you understand how they work. But let’s start with some basic concepts. Here are ten things home buyers in California should know about adjustable-rate mortgage loans:

1. ARM loans have an adjustable interest rate that can change over time.
2. They can also have an initial “fixed” stage where the rate stays the same.
3. ARM loans typically have lower rates than fixed-rate mortgages (initially).
4. The interest rate can adjust annually or at predetermined intervals.
5. These adjustments can result in higher monthly mortgage payments.
6. Caps and limits protect borrowers against extreme interest rate fluctuations.
7. Consider future income potential and financial stability before choosing one.
8. Understand the specific index, margin, and adjustment frequency of the ARM.
9. Have a contingency plan and financial reserves to manage payment fluctuations.
10. Evaluate your risk tolerance and ability to handle potential payment increases.

Understanding Adjustable-Rate Mortgages

Adjustable-rate mortgages (ARMs) have an interest rate that can change over time. This change might occur every six months, once per year, or every few years – depending on the specifics of the loan.

The interest rate for an ARM is composed of two main components: the index and the margin. The index represents the base or benchmark interest rate, while the margin is a predetermined percentage added to the index. For example, if the index is 3% and the margin is 2%, the initial interest rate for the ARM would be 5%.

The adjustment frequency and the specific terms of the adjustment will be outlined in the loan agreement. Typically, ARMs have an initial fixed-rate period, during which the interest rate remains stable and unchanging. After this initial period, the rate will adjust periodically, typically annually or every few years, based on the specific terms of the loan.

Unlike the ARM, fixed-rate mortgages (FRMs) have a constant interest rate throughout the entire loan term. FRMs provide borrowers with stability and predictability, because borrowers know that their rates will never go up.

Key Features of ARM Loans

If you’re thinking about using an adjustable-rate mortgage loan to buy a home in California, there are some important concepts and terminology you should understand. Here are some of the key features of ARM loans:

Initial fixed-rate period: Adjustable-rate mortgages typically start with an initial fixed-rate period, during which the interest rate remains constant. This period can range from a few months to several years, depending on the terms of the loan. It provides borrowers with stability and predictability for an initial period before the potential adjustments begin.

Index and margin: The interest rate adjustment for ARMs is based on an index, such as LIBOR or the Treasury Bill rate. The margin is a predetermined percentage added to the index to calculate the new interest rate. California home buyers should understand the specific index and margin used in their ARM, because they can influence the future interest rate adjustments.

Caps and limits: ARMs often include caps or limits to protect borrowers from drastic interest rate fluctuations. Periodic adjustment caps limit the amount the interest rate can change at each adjustment period. Lifetime caps impose a maximum limit on the interest rate increase over the life of the loan.

Adjustment frequency: This frequency determines how often the interest rate is recalculated and adjusted. This frequency can vary depending on the loan terms, with common periods being one year, three years, or five years. The adjustment frequency directly affects how frequently borrowers can expect changes in their mortgage payments.

Should You Use One When Buying a Home?

So now you know (A) what an adjustable-rate mortgage is and (B) how it can behave over the long term. But how do you know if it’s the right financing option for you?

Here are some scenarios where it might make sense for a home buyer in California to use an ARM loan:

Buyers with short-term homeownership plans

Adjustable-rate mortgages (ARMs) can be attractive for buyers who have short-term plans for homeownership. If you anticipate selling the property or refinancing within the initial fixed-rate period of the ARM, you can take advantage of the lower initial interest rate.

By the time the adjustment period begins, you may have already transitioned out of the mortgage, avoiding potential payment increases.

For example, if you plan to relocate for work or expect changes in your housing needs within a few years, an ARM could provide you with lower monthly payments during the initial fixed-rate period. This can free up more funds for other purposes or allow you to save for future housing plans.

Buyers who anticipate an increase in income

Buyers who expect an increase in income in the near future may find adjustable-rate mortgages appealing. With an ARM, the lower initial interest rate could provide immediate affordability, allowing you to qualify for a higher loan amount based on your current income.

If you anticipate a promotion, a career change, or additional income sources in the coming years, an ARM can help you secure a home sooner and take advantage of the lower initial payments.

Questions? If you’re planning to buy a home in California in the near future, we encourage you to continue researching your mortgage options. And feel free to contact our staff with any financing questions you have. Bridgepoint Funding offers a wide range of home loan options, including both fixed and adjustable-rate options.