Adjustable-rate mortgages generally get a bad rap. But in some cases, choosing an ARM rather than a fixed-rate mortgage makes more sense and can potentially save you thousands of dollars over the life of the loan. We want to equip you with a solid understanding of the terms available before choosing the right product for your set of circumstances.
Following are a few things for you to consider:
While fixed-rate mortgages provide the security of steady payments, they can end up being more expensive in the long run when compared to an ARM loan. “Fixed” means your rate won’t change. With an ARM loan, your rate can change. Adjustable-rate mortgage payments increase or decrease based on current market rates of interest (that are out of your control). When rates move lower, that can translate to lower monthly mortgage payments. But they can also go up, so you should consider the maximum amount your monthly mortgage payment could increase.
Interest rates for fixed-rate mortgages are currently on the rise, making ARM loans a better option for some with a lower initial rate. Like fixed-rate loans, the initial interest rate and monthly payment for ARMs will remain in effect for a certain period of time — you can choose from 1, 3, 5, 7 or 10 years — and then the rate adjusts and your payment amount changes every year after.
Some ARMs place a cap on the interest rate, limiting the amount the interest rate can increase from one period to the next. The cap can limit the amount the rate can be adjusted from one period to another, and if your loan has a lifetime cap, it will limit an increase over the life of the loan.
There are other advantages too:
- Limited risk
ARMs are less risky than they used to be because lenders offer interest-rate limits to protect you from major rate changes. You know upfront the highest your rate could go, the frequency of any adjustments and the amount by which your payments could change.
- Bigger savings
Initially, ARMs can be as much as two percentage points lower than fixed rate loans, which translates into major savings in the first years of your loan term!
- Lower interest rates
ARMs typically have a lower starting interest rate and monthly payment, compared to fixed-rate loans. This can be an ideal option for homebuyers who will likely only have the loan for a few years because of retirement, relocation or if you plan to quickly pay off the loan. Note: You’ll want a loan without a prepayment penalty, if you plan to sell your home or refinance within the first five years of the mortgage.
- No need to refinance
When interest rates decrease after your initial period, ARMs automatically give you the advantage of lower interest rates without paying new closing costs and fees associated with refinancing fixed-rate loans.
[This is the part of the post that reminds you to carefully consider your options! The best loan for you depends on your specific situation, short- and long-term financial goals, the cost of the home you plan to buy and how long you plan to live there.]
As always, be sure you understand the terms and conditions and consider the worst-case scenario to ensure the payments would be affordable before you sign your closing documents.