Why a 5 Year Adjustable Rate Mortgage Could be Right

A 5 year adjustable rate mortgage may be able to give you the low payment you are seeking. Home buyers are eager these days to purchase homes that are either discounted or have reduced in value due to the housing crisis. To do so they are looking at different types of mortgage products than the conventional ones such as 30 year or 15 year fixed rate mortgage loans. Among these alternative mortgage products home buyers will find the 5 year adjustable rate mortgage (ARM) loan or the 7 year ARM. These types of loans are attractive for several reasons.

With a 7 year or 5 year adjustable rate mortgage, the borrower pays the monthly payment at the prevailing interest rate which is fixed and will not change for the first 7 or 5 years, whichever he chooses. The longer the fixed term, the higher the rate usually. Payments for this fixed period are usually not amortized and are interest only, which means that the entire payment goes towards interest and none of it goes towards reducing the principal balance amount.

This is attractive in that it helps to lower the monthly payment. For borrowers and home buyers on a fixed income or salary, this helps them to afford a more expensive home or rental property than would have been the case if their payment was based on a 30 year fixed rate, which is fully amortized.

Also if the borrower knows ahead of time that he is going to sell the property within the next few years, why should they pay the higher interest and monthly payment of a 30 year fixed rate? It does not make sense and an ARM could be just the thing for them.

When considering a borrowers request for financing, banks and lending institutions look at a borrowers ability to repay the loan. The main thing that they look at is earnings and a borrowers salary or, if they are self-employed, the borrowers income tax returns and profit and loss statements as prepared by a CPA. Usually the debt to income ratio (DTI) that the bank will accept should be no greater than 45%. This means that if a borrower has a monthly income of $10,000 for example, then his combined debt, including his housing payment (loan, taxes, insurance, etc.) cannot exceed $4500 in order to qualify for the loan. This is difficult and may require some cutting back by the borrower. Credit cards may need to get paid off, or auto loans in order to qualify

Banks and lenders are very stringent about this requirement and will not make allowances. This is one of the reasons why a 5 year adjustable rate mortgage can be an attractive alternative for many home buyers. Because their monthly payment will be interest only, it will naturally be less than the same loan amount at a fully amortized payment. This could be just the ticket for qualifying.

The downside is that a 5 year adjustable rate mortgage will not stay fixed forever and eventually, after 5 years, will become an adjustable rate. Since we cannot say for certain what rates will be like in 5 years, this is a big gamble and not one that many home buyers will be willing to make.