Posted by Christine Owens on July 27, 2017
Adjustable-Rate Mortgage Pros and Cons
Adjustable-rate mortgages have developed quite a reputation over the years. When the mortgage crisis happened many people with adjustable rate mortgages were in big trouble and ended up having to enter foreclosure. But, just because adjustable-rate mortgages got a bad rap during the housing crisis does not mean they are inherently bad. In fact, for the right buyer they are a great option. Adjustable-rate mortgages, aka ARMs are different than a traditional fixed-rate mortgage with which most people are familiar. When you buy a home using a fixed-rate mortgage you agree to pay a certain mortgage rate for a predetermined length of time (for example: 30 years). The mortgage lender guarantees that that rate will never change during the life of the loan so your mortgage payment will stay, more or less, the same over the length of the loan. With an ARM, your rate will be fixed for a predetermined length of time (for example: 5 years) and after that period, the rate will periodically change (often annually) based on the market. If you are deciding what type of home loan is right for you and considering an ARM, it is important to weigh the pros and cons of ARM loans so that you can make the best decision for your unique circumstances.
- PRO: Lower Mortgage Rate
- An ARM loan is often appealing to buyers because it almost always comes with a lower mortgage rate. That means lower monthly payments so you can potentially buy more home for less of a monthly payment than you would otherwise be able to. The New York Times explains why this is so, “’You’re paying a premium for a 30-year fixed,’ he said. ‘It’s the safest, but it’s like, how much life insurance would you buy?’ Adjustable loans, which are usually amortized over a 30-year term, carry greater risk for the borrower, because the rate may rise after an initial period of fixed interest. Lenders offer various options for the length of that initial period, with 3, 5, 7 and 10 years being the most common. Rates are lower on the shorter ARMs, but ‘most people want the longest ARM these days as it’s the next best thing to a 30-year fixed,’ Mr. Grabel said.”
- CON: Adjustments Could Make Payments Unaffordable
- With an ARM, once your fixed-rate period has come to an end, your mortgage rate will adjust according to the market. Here is where the gamble comes in – if the market is steady the rate may not adjust much but if something dramatic happens to the market and the rate balloons, so will your mortgage payment. You have to determine if you can take that risk. Will you be able to afford your home if your mortgage rate increases significantly?
- PRO: Great For Someone Who Is Likely to Move/Relocate Soon
- If you like to move around or work in a job that frequently requires relocation, an ARM may be great for you. For example, if you know you will have to move in 3 years but still want to own a home, a 3 or 5 year ARM would be a great choice because you will pay a lower mortgage rate but will not endure the risk of a fluctuating mortgage rate after the fixed-rate period has ended.
- CON: Complicated
- There are many different types of ARMs with many different requirements, potential fees, and unique loan conditions. Understanding your unique ARM is important because if you do not, you could end up paying big fees for something like prepayment. Additionally, there may be little-to-no consistency with your mortgage payment amounts so that can be confusing for a homeowner and if you do not pay the right amount you could encounter additional fees. Potential conditions that can change your mortgage payments and make an ARM confusing are things like: adjustment frequency, adjustment indexes, balloon payments, interest-rate caps, payment caps, discounted initial rate, points, and more.