An adjustable-rate mortgage (ARM) can look attractive with low introductory rates and more flexibility. But is an ARM the right choice for you?
If you move around the country for work frequently, a variable-rate mortgage might be the perfect fit.
We will look at the pros and cons of this type of mortgage and how it compares to a fixed-rate home loan.
What is an adjustable-rate mortgage?
Many potential home buyers ask what is an adjustable-rate mortgage and how do they work.
An ARM gives borrowers a low fixed rate at the beginning of the mortgage. This teaser interest rate could last up to 10 years, but it becomes a variable rate mortgage when this ends.
The mortgage terms will state how much the interest rate can increase or decrease compared to the benchmark rate when the initial period ends.
If you don’t expect to live in the home for too long, you could benefit from the low-interest rate and then sell before the variable rate kicks in.
If interest rates are rising due to a market change, it might be the best option to get a lower rate.
The pros of an adjustable-rate mortgage
What are the advantages of an adjustable-rate mortgage?
Low mortgage payments
In the beginning, you will save a lot on your monthly outgoings during the fixed interest period. For the initial 3, 5, 7, or 10 years, you can expect a predictable and low, mortgage payment schedule.
Benefits short-term ownership
If you expect to move in a few years, you can take advantage of the low-interest rate without worrying about the variable period.
Rate caps are in place
When the fixed period ends, your lender can’t increase the rate by any amount. There are caps on how much the interest rate can change and how frequently this will happen.
You could reduce your mortgage payments
When interest rates fall, the amount you have to pay could be reduced when the interest rate changes for the ARM.
Down payment requirements don’t change
When using an adjustable-rate loan, you don’t need to come up with a larger down payment. The down payment requirements stay the same whether the rate is fixed or adjustable.
The cons of an adjustable-rate mortgage
What are the downsides of an adjustable-rate mortgage?
With rises in interest rates, the amount you will need to pay on your adjustable loan will increase. This could put you in a difficult financial position.
How an ARM works encourages a borrower to plan what they will do when the adjustable period begins.
However, things can go wrong. Perhaps you can’t find a buyer, or refinancing doesn’t work out. And if things don’t go to plan, you will need to find more money each month or face foreclosure.
The way an ARM is structured can be complicated. They have rules and fees that could catch out the unwary borrower.
Should you choose an adjustable-rate mortgage?
The lower rates offer many benefits if you fully expect to pay off the mortgage early when you move home. But if the unpredictability of the variable rate doesn’t sit well with you, perhaps this isn’t a good mortgage option.
Also, if you anticipate living in the home for a long time, there could be better mortgage types. In a situation like that, you will have to deal with the changing monthly payments or cover the additional costs when refinancing.
If interest rates increase before you refinance, you could find that you would have been better off by locking in a lower rate when you had the chance.
Before you choose, you should ask a loan officer exactly what your payments could be, so you can better evaluate your options.
Final thoughts on ARM loans
Adjustable-rate loans aren’t the best mortgage choice for everyone but they could make perfect sense for you. Speak with a mortgage professional to determine if this loan option makes the most sense.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell MetroWest Massachusetts real estate for the past 35 years. Bill is the owner and founder of Maximum Real Estate Exposure. For the past decade, he has been one of the top RE/MAX REALTORS® in New England.