Adjustable Mortgage Rates - The Pros and Cons Explained.
09.15.2020 | Category: Homebuying
One key decision that you’ll need to make during the mortgage process is whether you’ll purchase your home with a fixed rate or adjustable rate mortgage (ARM). Each has pros and cons that should be considered during the decision-making process.
What is an Adjustable Rate Mortgage?
An ARM or Adjustable Rate Mortgage is a mortgage loan where the interest rate may change over the life of the loan. ARMs are typically structured so the interest rate on the loan will remain fixed for an initial period of time, and then adjust annually. For example, with a 5/1 ARM - the interest rate for the first 5 years would remain fixed. After that initial 5-year period, the interest rate on your mortgage will then adjust annually based on market rates and conditions. Adjustable rate mortgages offer less stability than their fixed mortgage counterparts, but typically offer borrowers lower interest rates at the beginning of the loan. If you’re only planning to be in your home for a short period of time or are looking to qualify for a larger loan amount, an adjustable mortgage rate may be a good idea.
How does an ARM work?
With an ARM, your mortgage interest rate is likely to change over the life of your loan, causing your monthly mortgage payment to increase or decrease based on market conditions. ARMs are typically structured so the interest rate on the loan will remain fixed for an initial period of time, often 5, 7 or 10 years. After that initial period, the interest rate on your loan will typically adjust on an annual basis. ARM’s can be advantageous for homebuyers who don’t plan to live in their home for more than 7-10 years. ARMs can also offer more favorable interest rates compared to fixed rate mortgage counterparts during their initial fixed term. It’s important to think about your long-term goals as you evaluate home loan programs and mortgage options.
Pros and Cons of Adjustable Rate Mortgages
Pros of ARMs
- Flexibility - If you think your lifestyle could change in the next few years, or you only plan to live in your home for a limited time, an ARM can provide upfront savings on your new home purchase.
- Possible Decreasing Monthly Payments - Often when we talk about adjustable rate mortgages, we’re warning against the possibility that your interest rate and monthly payment could increase. But the opposite is also true. If market rates fall, after your initial lock period, your mortgage rate and payment could decrease.
- Lower Monthly Payments Upfront - ARMs usually offer more favorable interest rates upfront compared to fixed rate mortgages during their initial fixed term.
Cons of ARMs
- Less Stability - ARMs may have less stability than fixed rate mortgages, and can be harder to budget for over the life of the loan. If your plans change and you decide to stay in your home long term, you could look into refinancing your mortgage into a fixed rate.
- Possible Increase To Monthly Payments - While it’s impossible to predict the future, if you purchase your home with an adjustable rate mortgage you need to be prepared for the possibility that your interest rate and monthly payment could increase.
- ARM’s Are Complex - ARMs can have complicated rules, fees and terms. It’s important if you are considering an ARM that you work with your loan officer to fully understand the terms of your loan and payment structure.
Is Adjustable Mortgage Rates Loan a Good Idea for You?
The advantages of adjustable rate mortgages may make sense for homeowners seeking short-term benefits, but don’t necessarily align with everyone’s goals. Luckily, you don’t need to make major financial decisions on your own.
If you’d like to learn more, our Adjustable Rate Specialists are happy to help explain the pros and cons of an ARM.