Watch Out: How Easy Is It To Refinance An ARM Loan?
ARM Loans—they’re all the talk right now. But should they be? Before you convince a buyer to take out an ARM loan for their purchase, make sure you both understand the future implications, especially when dealing with refinancing options.
We are passionate about putting out correct information, whether you work with us or not, so let’s get into it.
What is an ARM Loan?
First, let’s briefly touch on what an ARM Loan is for any future buyers who may be reading this. ARM stands for Adjustable Rate Mortgage. It’s a type of home loan with an interest rate that adjusts based on the market, and buyers usually start with a slightly lower interest rate than a fixed-rate loan option—which can seem great at the surface level, before you look under the hood.
So it’s no surprise that with the recent rise in interest rates, ARM loans have been all the buzz! Buyers can get in with a 1% lower rate with the intention to refinance later when the rates go down.
As well-intentioned as that idea may be, it’s not quite so simple—or everyone would be doing it!
Buyers who are in this for the long term should be presented with ALL the information, so they don’t fall into something that seems great on the front end but could end up burning them later.
If ARM Loans aren’t all they’re chalked up to be, why are they being pushed right now? It’s a good short-term fix when a buyer is shocked by a sudden increase in rates and could convince them to get into a home sooner than later. BUT if they are promised an easy refinance option down the road, they may be upset in the future that they weren’t presented with more options.
In fact, what they should know is that it’s EASIER to refinance a fixed-rate loan. But why?
If you take out two loans for an ARM without money down, your only option to refinance into a fixed-rate product would require an appraisal on the home and at least 5% equity. If rates drop in one or two years, would you really have that much equity when you may be purchasing at the top of the market?
And since ARM loans are typically tied up in two loans, it makes the refinance (for some programs) considered a “cash out.” That raises the interest rate and gives some loan-to-value limitations, which could lead to the buyer needing even more than 5% equity to refinance.
It’s also good to remember that in-house ARMs are unique to our market and someday could come to an end. Keep that in mind if the bank is promising that they can just put the buyer into another ARM.
To wrap it all up, with an ARM, there are NO GUARANTEES. And why risk it if it’s not an absolute?
What Can We Do Instead?
We never like to push buyers into options where they MUST refinance in the future, which is often the case with most of the two loan ARMs since the 2nd will have a balloon payment due in the future.
However, we know the market right now, and we, like all Americans, hope rates will come down to the ‘normal’ we were accustomed to these past few years. Putting buyers into mortgage programs that make those refinance options as easy and affordable as possible is the best way to take care of buyers for years to come!
Luckily, we have options! Rural Development, VA, and FHA loan programs offer streamline refinance products that make it extremely easy to do a rate decrease without an appraisal and often allow limited documentation.
Rural Development Loan
If a buyer closes with an ARM, they cannot refinance into a great product like a Rural Development loan. We have seen this come up with clients—and unfortunately, it is simply not an option. Most often, those who ask us wish they had known that before choosing an ARM!
However, if they purchase a home with an RD loan upfront, they can do a “Rural Development streamline refinance” once rates drop. No appraisal is required, and with its limited documentation (with a reduced rate), RD loans are a much better option for buyers who qualify and are looking for a bit of rate relief.
If a buyer goes with an ARM over a VA loan, they can refinance into a VA loan but may be required to have 10% equity to refinance—which, as we mentioned above, is not always an option for buyers—and is not a streamlined process.
However, if they purchase with a VA loan, they can do a “VA streamline refinance” once rates drop. No appraisal is required, no documentation is required, and it is super inexpensive and easy.
Also—don’t forget this loan program is typically a .25% to .50% lower rate than conventional fixed-rate financing and allows for 100% financing when purchasing a home or doing the rate/term refinance. This program also NEVER has monthly mortgage insurance, even when financing 100% of the purchase price.
If a VA loan is a qualifiable option upfront, there is NO reason to go with an ARM loan instead.
If they don’t qualify for a VA or an RD loan, that doesn’t mean they are out of great loan options for potential future refinancing.
Conventional Loans may not have the buzz factor of a 1% less interest rate, but if they are planning to be in their home for the long term, these loans are a much better option for easy refinancing. As the saying goes…Date the rate, marry the house!
Conventional loans offer a streamlined refinance option if you’re going from fixed rate to fixed rate. So let’s say in a few years, rates do go down significantly, then they should be able to easily refinance into that new, lower, fixed rate.
Another perk is that appraisals are not always required for conventional loan refinancing, so the stress of the value of the home may be eliminated.
Buyers and realtors, beware and remember that if you use a lender that only pushes an ARM, the option will not be as easy to refinance down the road as you might be led to believe—leaving you wondering why you didn’t get better information upfront.
With ARM loans, there are simply no guarantees, and we have alternatives for buyers that offer easier refinance options!
We also often make it a point to contact the buyer’s agent down the road when we see refinancing as a good option for a client of theirs, so realtors can then call with the great news, and buyers can easily refinance—a win-win! So come see us, and we will get you or your buyer into a great loan option!