The Pros and Cons of Adjustable Rate Mortgages
With mortgage rates remaining higher, many buyers are considering adjustable-rate mortgages (ARM) for their future home purchase. While fixed-rate mortgages provide homeowners with the same interest rate for the duration of their loan, interest rates for adjustable-rate mortgages can change over time. These loans are more complex than their fixed-rate counterparts. Here are the key points to consider when comparing the loan types.
What are ARM Loans?
Adjustable-rate mortgages (ARMs) are loans that come with a lower fixed interest rate for a specified period of time. The lower rate period is typically fixed for anywhere from one to ten years. After this initial low rate period, your rate will change to an adjustable interest rate, tied to market conditions.
For example, a 7/1 ARM means that you will have a fixed lower rate for the first seven years of the loan. At any point during those seven years you can refinance your rate or sell the home. Beginning in year eight, if you still have the loan, your rate will change once per year for the remainder of the loan. Your new interest rate, years 8-30 will be determined by the market conditions. As an added protection, there are typically caps, or limits, on what the new rate can become. For example a 2/6 cap means the rate could never change more than 2% from the prior year, or 6% over the life of the loan.
Pros of ARMS
There are many benefits associated with adjustable-rate mortgages. The primary benefit, of course, is lower monthly mortgage payments during the initial fixed-rate period. Historically, most homeowners either sell or refinance their home every seven year. Therefore, many people ask, why pay the higher fixed rate to guarantee your loan for 30 years?
These loans are also appealing to buyers who aren’t looking for their forever home just yet. If you are anticipate relocating, changing jobs, or upgrading to a larger home in a few years, you could sell your property while still within the fixed-rate period and never have to worry about the adjustable-rate period.
Also, especially if you are a younger professional, your income is likely to increase. It is possible that lower payments today, with potentially higher payments in the future, is a more attractive option than locking in today with a higher fixed 30 year payment today.
Cons of ARMS
ARMs do have their share of risks as well. The primary risk is that, after the fixed period, your payments could easily increase. If nationwide interest rates rise, your monthly mortgage payments will go up once the adjustable period begins.
Depending on your stage of life, these potentially higher payments could be a problem. Are you anticipating higher debts and lowing income in the future? Are you considering scaling back at work to return to school for a higher degree? Or looking at starting your own business? Do you have upcoming tuition payments for your children?
Also, keep in mind that life does happen. Things do not always go according to plan. Even if you have prepared for yourself for the adjustable period, you may find yourself in a situation where those higher payments are difficult to cover.
There are many factors to consider when choosing your loan type. Which one is right for you and your specific situation? Adjustable rate mortgages offer you significant savings during the initial interest rate period. And many people will be selling or refinancing before any higher payments kick in. However, after that initial savings period, your payments are unpredictable. For some people, the risk is not worth the upfront savings.
Your lender can talk you through all the loan options, and show you historic and worst case senecios after the adjustment period. Weigh your options, think about your future income and expenses, consider how long you will likely keep the loan, and make a fully informed decision.