Was it a bad idea to opt for an adjustable-rate mortgage (ARM) before inflation and interest rates spiked? It might seem so, but I don’t think so. Here’s why.
At Financial Samurai, I get a lot of feedback—both praise and criticism. This discourse is valuable; it prevents me from existing in an echo chamber and helps me refine my strategies. Recently, there’s been a lot of talk about my earlier endorsement of ARMs, especially after the sharp increase in inflation and mortgage rates. Looking back, I’ve advocated for ARMs since 2009, long before I started Financial Samurai, believing they were a wise choice given the historically low rates.
To address the latest criticisms head-on, let’s unpack the argument that taking out an ARM now is poor advice. One longstanding reader, Deon, argues that with 30-year fixed mortgage rates as low as 2.5%, opting for an ARM instead seems reckless. Indeed, locking in a 2.5% rate for 30 years does seem attractive, but if those were the conditions back in 2020, you could probably secure an even lower rate, say 1.75% on a 7/1 ARM. Over seven years, that difference accumulates significant savings in interest.
Moreover, ARMs come with caps on how much the interest rate can increase once the initial fixed period ends, usually no more than 2% the first year and 1% in subsequent years. So, even if rates skyrocket, the increase in your interest payments is moderated by these caps.
Now, let’s consider the average duration homeowners keep their property. As of 2023, it’s about 11 years, and the break-even point where a 30-year fixed mortgage becomes more economical than an ARM—in a worst-case scenario—starts around year 10. So, if you’re likely to move within that period, an ARM could still be financially advantageous.
Furthermore, consider the role of inflation in property and rental prices. Generally, a strong economy marked by inflation sees a rise in these values. Thus, the potential increase in property value could far outweigh the costs of higher interest payments in the future.
Debates about ARMs often miss how inflation can bolster property values significantly. For instance, if you bought a property for $1 million in 2020, it might be worth up to 50% more by 2022. Even if your mortgage interest rate under an ARM adjusts upward after the fixed period, the financial benefits from the property’s appreciation and the initial lower interest payments can mitigate the impact of higher rates later on.
In conclusion, whether an ARM is the right choice depends heavily on your financial situation, how long you plan to stay in your home, and how you handle potential future rate increases. While some might value the certainty of fixed payments over 30 years, others might find the lower initial rates of an ARM more aligned with their financial strategies, especially if they plan to sell or refinance before the rate adjusts. Always consider your personal financial landscape and long-term goals when making mortgage decisions.
