Lenders Shop a New Type of Loan, But is it Worthwhile?

• January 24, 2014
• 4 Comments

by Lark Turner

A new adjustable-rate mortgage is being hyped as a way for home buyers to lock in great rates, but critics say the plan is entirely dependent on market timing, according to The Wall Street Journal.

The new mortgage, called the jumbo 5/5 ARM, has a fixed rate for five years and then resets to another rate for the next five years, usually repeating for the life of the loan. It’s being shopped to wealthier buyers.

Per the WSJ:

“Lenders say this mortgage provides borrowers with more certainty because the required monthly payments don’t change as often as they do on other ARMs. … Critics say this mortgage only works in borrowers’ favor if they happen to time the market right.”

Banks are trying to make the deal more palatable to buyers by offering various incentives alongside it, and are raising rates on 10/1 ARM plans that would lock in a rate for 10 years. Buyers concerned that the second five-year rate will be too high can sign up for a plan that would allow them to reset it earlier than scheduled, but at one bank mentioned, buyers who did so were penalized by a slightly higher rate.

So would you sign up for the jumbo 5/5? A buyer who gets lucky and times it right could lock in great rates. But if you sign up before rates fall or your five-year reset comes at an inopportune time, you could be kicking yourself for half a decade. A mortgage expert cited in the article called the plan a “crapshoot.”

This article originally published at https://dc.urbanturf.com/articles/blog/a_new_type_of_loan/8039

4 Comments

1. David said at 6:24 am on Saturday January 25, 2014:
   This is not new, Pentagon Federal Credit Union has been offering a 5/5 ARM for years. Coming out ahead versus a 30 yr fixed will depend on the initial rate and the maximum rate increase at the first adjustment. The issue is how much you save with a lower rate for the first five years and how long after that it takes to burn off the savings.

1. Rick said at 4:05 pm on Monday January 27, 2014:
   The PenFed 5/5 ARM is a great product. I snagged one in October with a 2.75% teaser rate and a 2% cap for each adjustment (7.75% lifetime cap). A hypothetical example on a jumbo loan ($750k): 5/5 ARM Rate: 2.75% first 60 months, 4.75% next 60 months Tenor: 360 months Principal Payments (first 60 months @ 2.75%): $86,280.77 Principal Payments (second 60 months @ 4.75%): $80,818.65 Total Principal Payments (first 120 months): $167,099.72 30-Year Fixed Rate: 4.25% Tenor: 360 months Principal Payments (first 60 months @ 4.25%): $68,942.28 Principal Payments (second 60 months @ 4.25%): $85,233.47 Total Principal Payments: $154,175.74 Result: $12,923.67 more paid off in 10 years with 5/5 ARM than 30-year fixed. Couple the above with the fact that most mortgages are paid off (via sale of home or refinance) within 7 years and this is a no-brainer.

1. Rick said at 4:23 pm on Monday January 27, 2014:
   I see the PenFed teaser rate is now 3.00%. Repeating the above example: 5/5 ARM Rate: 3.00% first 60 months, 5.00% next 60 months Tenor: 360 months Principal Payments (first 60 months @ 3.00%): $83,202.27 Principal Payments (second 60 months @ 5.00%): $78,650.01 Total Principal Payments (first 120 months): $161,852.28 30-Year Fixed Rate: 4.25% Tenor: 360 months Principal Payments (first 60 months @ 4.25%): $68,942.28 Principal Payments (second 60 months @ 4.25%): $85,233.47 Total Principal Payments: $154,175.74 Result: $7,676.54 more paid off in 10 years with 5/5 ARM than 30-year fixed.

1. JT said at 4:08 pm on Thursday January 30, 2014:
   Rick is right on. You can refinance just like any other mortgage too. How is locking in to a rate for 30 years any less of a crap shoot? Is a permanently higher rate somehow better than a lower rate for 5 years and the potential for it to stay low? The key with the PenFed / First Savings program is that the first and all subsequent adjustments is only a max of 2% (5% lifetime). With the typical 5/1 ARM it can go up 5% at the first adjustment if the benchmark rate dictates that it does. Many borrowers, young people especially, are paying way more interest than necessary because they will only own the home for 5 - 10 years. You can't take your super low 30 yr fixed mortgage with you to the next property...why pay more interest and less principal than you need to?