The Pros and Cons of Adjustable–Rate Mortgages
In the world of real estate, an adjustable-rate mortgage, aka ARM, is a home loan that provides you with a low fixed-interest “teaser” rate for five to ten years, followed by a time of periodic rate adjustments. Fixed-rate mortgages are different than ARMs, which will keep the same interest rate for the duration of the loan.
In this article, we will take a deep dive into understanding how an adjustable-rate mortgage works and its pros and cons.
How Do ARMs Work?
Your payments with ARMs can either increase or decrease with interest rate changes based on the terms of your loan and the benchmark rate index. Choosing an ARM over a fixed-rate mortgage can be a solid financial decision on your end, saving you tons of money in the process. While fixed-rate mortgages are more common, ARMs can be a great option for house hunters who know they plan on having a loan for only a couple of years.
Pros of ARMs
Low Payment Options
ARMs offer savings in the initial fixed-rate period. For example, with a five-year ARM, the introductory interest rate will be locked in for that timeframe before being subject to change. This will give you a five-year timeline of predictability and low payments. The initial low rate might also allow you to qualify for a bigger mortgage than you would find with a fixed-rate loan. However, keep in mind that you may have to make higher monthly payments down the road if necessary.
Flexibility
An ARM is a good idea if you expect any life changes in the next few years, such as moving or selling your home. You can enjoy the fruits of ARMs’ fixed-rate period and sell before it expires and the less predictable phase begins.
Payment Caps and Rate
ARMs come with caps that will limit how much the mortgage rate, and your payment will see an increase. This will include caps on how much the rate will change each time it adjusts and the total rate change over the lifespan of the loan.
A Decrease in Your Payment
If the interest rates fall and the index is driven down, which your ARM is benchmarked at, your monthly payment is subject to drop. If this seems likely, you might be tempted to opt with an ARM, but it is safe to make this decision based on your personal circumstances, not what you predict the market will do.
Cons of ARMs
Payments Can Increase
If interest rates rise, you will see an increase in your payments after the adjustable period starts. Some borrowers will have trouble making such large payments.
Things Don’t Go As Planned
ARMs will require borrowers to plan for when there is a change in interest rates and monthly payments are subject to grow. Even with timely and careful planning, you may be unable to sell or refinance when you wish to. If you cannot make the payments after the fixed-rate phase of the loan, you might lose the home entirely.
They Can Be Complex
ARMs can come with a complicated set of rules, fees, and structures. These can pose risks for borrowers who don’t have a clear understanding of what they are getting into.
Bottom Line
Whether or not an ARM is a good idea for you will solely depend on your goals and comfort levels with unpredictable periods. If you opt to sell the home or pay off the mortgage before the adjustable rate rises, you will save money. However, an ARM may not be the right option if you are planning on settling in for a long time and need the certainty of a constant mortgage rate and payment. If this is the case, a fixed-rate mortgage is the way to go. Speak with a lender today to gain a clear understanding of what type of rate is best for you.