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Should You Get a Jumbo ARM if Rates Are About to Rise?

What you'll learn: Whether a jumbo loan is a good option in a rising rate environment.

EXPECTED READ TIME: 9 MINUTES

When rates are low, many homebuyers want to lock in their rates with a 30-year fixed-rate mortgage. Now that rates are rising, a big question exists as to whether or not you should choose a jumbo ARM. Jumbo ARMs can be very beneficial for specific buyers. We will go through the advantages of jumbo ARMs and give suggestions as to whether or not they are a good choice over a fixed-rate loan.

Advantages of Jumbo ARMs

The main difference between a fixed-rate mortgage and an ARM is that an ARM has a fixed-rate period that is between three and 10 years, and then it will shift to an adjustable rate.  

Conforming loans: Mortgages that meet the dollar limits and criteria of either Fannie Mae or Freddie Mac. Conforming loans are advantageous for borrowers with good credit due to their low-interest rates.

Jumbo ARMs are a type of nonconforming loan. A conforming loan is one that is backed by Fannie Mae or Freddie Mac. The thing that makes a jumbo ARM nonconforming is that it exceeds the maximum value for a loan allowed by the conforming limits.

Each county has its own maximum loan limits or conforming loans, but the most common conforming loan limit for 2022 is $647,200.

The biggest advantage that ARMs provide is that during their fixed-rate period, the interest rate they charge is significantly less than the rate of a fixed-rate mortgage.

Let’s consider some examples to see the difference this makes.

  • An example might be a fixed-rate jumbo mortgage that has a rate of 4.56%.
  • While a jumbo ARM 5/1 (a five-year fixed period, and the rate will then change yearly from year six until the end of the mortgage) has a rate of 3.73%.
  • Assuming a $750,000 loan, the fixed-rate mortgage will pay principal and interest of $3,832 while the ARM borrower will be paying $3,469.
  • This is a difference of about $363 a month and $4,355 a year. It is like paying one less payment a year.

The other advantage of jumbo ARMs is that, in general, lenders making the loans will keep the mortgage rather than sell them. This means the rules are not the same and you can get lots of personalization for these loans.

When you are in a time of falling rates, ARMs are beneficial because you are not locked into the high rate, and when the fixed-rate period ends, the floating rate may lower.

Why a Jumbo 5/1 ARM Could Be a Great Choice

When rates are rising, an ARM can be a great choice to lock in a low rate. The most significant deciding factor for choosing an ARM over a fixed-rate mortgage is the length of time you plan on living in the home. The advantage of selecting a 5/1 ARM over a fixed rate is you get a much lower interest rate and payment during the fixed-rate phase. If you plan to sell in less than 5-6 years, a 5/1 ARM could be an intelligent choice. If you plan on staying in a home for less than 7 years, then a seven- or 10-year ARM will be a good choice.

According to data published by iPropertyManagement, the average length of current homeownership is 16 years. However, the more interesting number belongs to homes sold in the last quarter of 2021, in which the average length of ownership was 6.3 years. The younger you are, the more likely you are to stay in a home for a shorter amount of time. And if you are buying a starter home or know you will be moving, an ARM is likely better for you because you will either have a lower payment every month than with a fixed-rate loan or you can get into a more expensive home for the same monthly payment.  

Comparing Jumbo ARMs With Jumbo Fixed

ARMs and fixed-rate mortgages generally have more similarities than differences, with the main differences between ARMs and fixed-rate mortgages being the initial rate and then a floating period.

They generally have similar qualifications, such as:

  • The typical down payment required for both types of loans is 20%, but they can range from 5-30% (ARMs will usually be 15% higher). A down payment of 20% or more means you will not need to pay private mortgage insurance. PMI adds to your monthly payment.
  • Your total monthly mortgage payment should be less than 38% of your pretax income.
  • Your debt-to-income ratio (how much you are paying for all loans — student loans, credit cards, etc. divided by your income) should be 43% or less. Many lenders require a maximum DTI of 36%.
  • You should have a minimum credit score of 680. The higher your score, the lower the rate you will receive for your mortgage.
  • You will be required to provide critical financial documents, such as:
    o    Proof of income.
    o    Proof of liquid assets (lenders will usually want to see that you have sufficient assets to pay for 6-12 months of mortgage payments).
    o    Proof of ownership of nonliquid assets.

Build Equity Faster With Jumbo ARMs

Jumbo ARMs allow you to build your home equity faster. If you have the funds to do so, a smart strategy might be to take out a 5/1 ARM and make monthly payments as if it were a 30-year fixed mortgage. By the end of the five-year fixed period, you will have made a much more significant dent in the balance than if you had chosen a 30-year fixed mortgage. Let’s use our above example of the $750,000 5/1 ARM loan. Over the five years, making the extra $363 in monthly payments over what is owed for the ARM, you will have paid the same amount as the 30-year mortgage. But you would have an additional $32,782.70 of equity in the home.

Is a Jumbo Variable-Rate Mortgage Right for You?

For those who need a nonconforming loan, a jumbo ARM can be a low-cost alternative that gets you into your dream home. An ARM will be the most economical choice for anyone who is sure of a move in fewer than 10 years. Because rates are rising, we don’t know where they will sit in 3-10 years when the adjustable-rate period will begin. If you know you will stay longer in the home, you will probably still be better off with a fixed-rate mortgage with the current low but rising rates. For others, the decision is harder. While it is ultimately yours to make, we have professional loan officers who can help you with your decision.

When rates are rising, a jumbo ARM could be the answer.
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