Finding a mortgage that fits your needs and lifestyle can be difficult when you’re unsure of how long you’ll actually live in a home. You obviously want to minimize long-term holding costs, which is why many consumers choose a 15-year mortgage right off the bat. Then again, the lower payments of a 30-year loan can be enticing as well — even though you’ll take twice as long to pay off your home loan in the end.
The 15/15 adjustable-rate mortgage (ARM) aims to offer the best of both worlds with low initial payments and a low initial interest rate. With this type of home loan, your “adjustable” rate will only change once during the entire loan process — typically when you are exactly halfway through repaying the 30-year loan.
This type of home loan, which is also referred to as a “Money Saver Loan,” is fairly rare, so it’s likely you’ve never even heard about it before. This guide aims to explain how the 15/15 ARM Money Saver Loan works, how it’s different from traditional ARMs and who it’s good for.
What is an ARM?
Before we dive into the mechanics of a 15/15 ARM specifically, it’s important to understand how ARMs typically work, and why they’re different from fixed-rate loans.
The biggest difference is the fact that fixed-rate mortgages come with interest rates that stay the same during the entire loan process. With an ARM, on the other hand, the interest rate changes periodically, based on an index. When the interest rate on an ARM adjusts up or down, your monthly payment amount will change with it.
Because lenders typically offer lower initial rates for ARMs, they are an enticing option for borrowers who want to purchase a home with low monthly payments. However, the fact that interest rates can also adjust upward with an ARM means that your monthly payments could end up higher than those you would have had with a fixed-rate mortgage.
All ARMs start with an initial rate and payment amount that can vary from one month to five years — and potentially much longer. There are also adjustment periods that dictate how often an interest rate will change and how long you’ll wait before the first adjustment. For example, a loan with its first adjustment period scheduled in three years is called a 3-year ARM.
Interest rates on ARMs are made up of two main components — the index and the margin. The index component is a measure of general interest rates that is typically based on an index such as the 1-year LIBOR, which stands for the London Interbank Offered Rate. When it comes to setting interest rates for ARMs, lenders add on a few percentage points, known as the “margin,” to make a profit. The index added to the margin becomes the fully indexed rate a consumer is actually charged on his or her mortgage.
If the index is at 4% and the lender adds 2% as the margin, for example, the fully indexed rate on the home loan would be 6%. But this is where things can get tricky. While the margin typically remains constant throughout the life of the loan, the index can change based on market conditions. If the index inches up a percentage point, so does the interest rate on your mortgage. Your monthly mortgage payment will also inch up along with it.
Fortunately, there are caps that prevent your ARM from rising to extraordinary heights. In addition to the initial adjustment period on an ARM, you’ll also find
- A periodic adjustment cap that limits how much the interest rate can move up or down in between adjustment periods after the initial adjustment period.
- A lifetime cap that limits how much the interest rate can rise over the life of the loan — by law, virtually all ARMS must have this cap.
How does a 15/15 ARM work?
A 15/15 ARM works differently than a traditional ARM because of a few reasons. First, its initial adjustment period is a full 15 years. Your interest rate will stay the same during that time, even though you have an “adjustable” mortgage. Second, the interest rate on a 15/15 ARM only adjusts upward once, at the 15-year mark.
Consumers may like this setup because a 15/15 ARM allows them to take advantage of a lower initial rate and monthly payment for the first 15 years of the loan. Because they are actually taking out a 30-year home loan, however, they may be able to qualify for a larger loan amount than they would otherwise.
How does it differ from a 5/1 ARM mortgage? A 7/1 ARM mortgage?
If you’re considering other types of adjustable rate mortgages, you’re probably looking at the 5/1 ARM and the 7/1 ARM. Both of these loans come with an initial fixed-rate period that is shorter than the 15/15 ARM, which could be a net positive or a negative depending on your situation.
With a 5/1 ARM, your interest rate is fixed for five years and can be adjusted once per year after the initial period is over. With a 7/1 ARM, on the other hand, the interest rate is fixed for seven years, with the ability to adjust up or down once per year thereafter.
It’s easy to see why someone would choose a 5/1 ARM or 7/1 ARM over a 15/15 ARM, particularly if he or she wants to stay in the home for only a few years before selling. As of this writing, PenFed Credit Union is offering 5/1 ARM rates as low as 4.125% for the first five years, and 7/1 ARM rates as low as 4.00% for the first seven years. Rates on the 15/15 ARM, on the other hand, start at 4.65%.
The big tradeoff you’ll make with a 15/15 ARM is that even though your starting interest rate is higher than some other ARM loan products, you’ll have that rate for a full 15 years. If you took out a 5/1 ARM or 7/1 ARM, you would be subject to potentially rising rates within a much shorter length of time. In a rising interest rate environment, you could even face an increasingly higher annual percentage rate (APR) and mortgage payment every year.
A lot of homebuyers opt for a 5/1 ARM or a 7/1 ARM because they plan to move or refinance their home within a few years after buying. That can make a lot of sense, considering the initially lower interest rate and monthly payment they’ll qualify for.
On the flip side, a 15/15 ARM can work better if you plan to stay in your home for several more years. Your rate may be higher, but you won’t have to worry about your payment inching up and wreaking havoc on your monthly budget.
Is a 15/15 ARM a good idea for borrowers?
There are numerous benefits that come with a 15/15 ARM, the first of which is the potential for a lower initial interest rate. Because mortgage lenders may offer more competitive rates on some loans than others, however, you should compare different loans and their rates before you assume the rate on a 15/15 ARM is a better deal.
Other benefits of the 15/15 ARM include
- The ability to use this type of home loan for the purchase of a new home or a refinance.
- An interest rate that will only adjust upward once during the entire life of the loan, even though your rate is adjustable.
- The ability to borrow more with a 30-year loan like a 15/15 ARM than you could if you took out a 15-year fixed-rate mortgage.
Of course, there are downsides that come with this loan as well, the first of which is the fact that the interest rate will reset by an initially unknown amount after the first 15 years of your home loan are up. If you plan to stay in your home for several decades, you may not like facing that type of uncertainty. If interest rates rise significantly while you’re in the initial period of your loan, you could even be in for a huge shock when your interest rate adjusts at the 15-year mark.
Second, the 15/15 ARM does tend to have higher rates than other ARM products. If you truly want to save as much as possible and don’t mind the risks associated with a 5/1 ARM or 7/1 ARM, one of those might help you secure a lower payment for the first few years you have your home loan.
The 15/15 ARM allows homebuyers the affordability of initial low monthly payments along with the security of knowing their interest rate will only adjust upward once. Because it’s a 30-year home loan in essence, a 15/15 ARM may also help homebuyers qualify for a larger loan amount than they would have otherwise.
Before you opt for the 15/15 ARM, however, it helps to think through your current housing needs. If you plan to stay in your home for many years, you may value the security of a fixed-rate mortgage more over the long haul. If you only plan to live in your home for a few years and want the lowest monthly payment you can qualify for, on the other hand, a 5/1 ARM or 7/1 ARM could be a better bet.
Weigh the pros and cons and think about what you want out of a mortgage. Once you have all the facts and take the time to compare several loans and monthly payments, it will be much easier to decide.