Note Buyers USA

ARMs versus GPMs

Some borrowers confuse ARMs with graduated payment mortgages (GPMs) because GPM borrowers experience an increase in the payments over time. With a GPM, however, you pay less during the first year so you can qualify for a larger loan; then, during the next four years, your monthly payments increase gradually. Thereafter, your payments remain the same for the next 25 years. Your lower monthly payments during the early years of the mortgage offset the higher payments you’ll make during the later years. For an example, see Table 2.

FHA, VA, and conventional loan programs offer GPMs with a variety of payment  schedules. Like an ARM, the GPM will usually help you buy more property. But unlike an ARM, you will know your future payments. An ARM’s monthly payments will adjust up or down according to swings in the market interest rates (subject to any floors or caps). Your GPM’s monthly payment will steadily go up, unaffected by changes in the market interest rate, until it hits its scheduled plateau. Also, during those early years of lower payments, your mortgage balance may actually go up. Before you accept this type of loan, just as with an ARM, closely review your payment and amortization schedules.
Borrowers Be Aware
Rather than caution “beware of ARMs and GPMs,” we should advise “be aware of ARMs.” As an intelligent borrower, prepare for the ups and enjoy the downs. Do not complain, “Gee, I’m shocked. I never knew rates could go up this much.”
Never use an ARM to achieve temporary affordability. Instead, use it when the odds lie in your favor—and you accept the fact that this choice could increase your payments.
The Upside of ARMs in Down Markets
Inthelate1980s,the California housing market was booming. Even though interest rates were around 9 to 10 percent, homebuyers, investors, and speculators pushed prices higher and higher. Then the recession of the early 1990s hit California hard. Mid- to upper-price-range homes fell in value by 15 to 30 percent. Unemployment rates approached 10 percent. By 1993 to 1994, mortgage interest rates dropped to as low as 6.0 percent.
Great time to refinance, right?
Yes. But falling property prices, layoffs, and job uncertainty blocked many recent buyers from refinancing at lower rates. Some couldn’t qualify for a new loan because of job loss or feared cutbacks. And among those who could qualify for a refinance (refi), most couldn’t swing the deal. Their property values wouldn’t support a new loan—unless they could bring cash to the closing table.
So, who did gain? Property owners who in the late 1980s had chosen ARMs. Their interest rates slid down. Some were able to convert their  ARMs to a 15-year or 30-year fixed-rate loan at the low rates that prevailed. Although no buyers like to consider down markets, they happen, especially in California and other sometimes volatile urban markets like New York City, Miami, Phoenix, Boston, and Washington, D.C. In those situations, ARMs give owners an advantage over fixed-rate loans, yet this advantage is rarely pointed out.
Few real estate agents or loan reps want to frighten buyers with talk of downturns. Nevertheless, view all outcomes that experience reveals to be possible (or in some cases, quite likely).