What’s the Downside?

Simply put, the downside of an ARM is the risk that your interest rate and monthly mortgage payment increase suddenly and significantly during the adjustable rate period.

In order to illustrate this concept, let’s take a look at the worst cast scenario for a 7/1 ARM as compared to a 30 year fixed rate mortgage.

In the case of a 7/1 ARM, the interest rate is fixed for the first seven years of the mortgage and then is subject to adjust annually for the remaining 23 years of the mortgage

Our example uses the following assumptions:downside

The chart below compares the monthly mortgage payments for the ARM (red line) and fixed rate mortgage (blue line) over the terms of both mortgages.

  • The interest rate and monthly mortgage payment for the ARM is lower than the fixed rate mortgage during the first seven years, the fixed rate period of the ARM.
  • The monthly mortgage payment for the ARM during the fixed rate period is $1,551 as compared to $1,814 for the fixed rate mortgage
  • BUT, beginning in year eight, the interest rate and monthly mortgage payment for the ARM increase significantly as the interest rate jumps from 2.750% to 7.750%, the maximum possible increase at the first adjustment period.
  • The payment for the ARM, which is amortized over the remaining 23 years is $2,465 vs $1,814 for the fixed-rate.

According to this example, the ARM requires $157,584 more in interest expense over the life of the mortgage as compared to the fixed rate mortgage Keep in mind this example represents the absolute worse case scenario, however these numbers become even more significant with the higher mortgage amounts which are the norm in California.

7 vs 30 chart

For an analysis of your current ARM, or if you have any questions, call Jean 310-429-8070.