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Adjustable Mortgage Rates - The Pros and Cons Explained.

09.25.2022 | Category: Homebuying

As rising interest rates continue to make buying a new home more expensive for potential buyers, we're starting to see the demand for adjustable-rate mortgages grow. As they become more popular, we wanted to provide a quick refresher on ARM's (adjustable-rate mortgages) and the 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 a buyer is only planning to be in their 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, the mortgage interest rate is likely to change over the life of the loan, causing the 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 the 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  long-term goals as buyers are evaluating home loan programs and mortgage options.

Pros and Cons of Adjustable Rate Mortgages

Pros of ARMs

  • Flexibility - If your client thinks their lifestyle could change in the next few years, or they're only planing to live in their 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 plans change and the buyer decides to stay in their home long term, they may want to consider refinancing their mortgage into a fixed rate.
  • Possible Increase To Monthly Payments - While it’s impossible to predict the future, when a home is purchased with an adjustable rate mortgage the homebuyer needs to be prepared for the possibility that the interest rate and monthly payment could increase.
  • ARM’s Are Complex - ARMs can have complicated rules, fees and terms. It’s important if a prospective buyer is considering an ARM that they work with a loan officer to fully understand the terms of the loan and payment structure.

Is Adjustable Mortgage Rates Loan a Good Idea?

The advantages of adjustable rate mortgages may make sense for homeowners seeking short-term benefits, but don’t necessarily align with everyone’s goals. 

If you’d like to learn more or are working with a client that has questions, our Adjustable Rate Specialists are happy to help explain the pros and cons of an ARM and answer any questions.

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