With mortgage rates climbing dramatically over the last year, many buyers are weighing the pros and cons of an adjustable-rate mortgage (ARM) for their future home purchase. While fixed-rate mortgages provide homeowners with the same interest rate for the duration of their loan, interest rates for adjustable-rate mortgages can change over time. These loans are more complex than their fixed-rate counterparts, which is why this guide may be helpful as you're considering all your options.
What are ARM Loans?
Adjustable-rate mortgages (ARMs) are loans that come with a fixed interest rate for a short period of time before changing to an adjustable interest rate. For the first 3-10 years, you'll pay a fixed interest rate that's lower than what you would initially receive with a fixed-rate mortgage. Once this initial period is over, the interest rate will change at different time intervals.
When you're approved for the mortgage, you'll find out how often your interest rate will change after the initial fixed period. If you obtain a 10/6 ARM, the fixed interest rate will last for 10 years, after which your interest rate will change every six months. In comparison, a 7/1 ARM comes with a fixed interest rate for seven years before switching over to an adjustable rate that changes once per year. Market conditions will determine if your rate goes up or down.
Pros of ARMs
There are many benefits associated with adjustable-rate mortgages, the primary of which is that you'll have low monthly mortgage payments during the initial fixed-rate period. Whether this period lasts three years or seven years, this phase gives you the opportunity to increase your savings before the interest rate changes. Having predictable payments immediately after you purchase a home should also reduce your stress levels.
These loans can also be appealing for buyers who aren’t looking for their forever home just yet. If you anticipate relocating, changing jobs, or upgrading to a larger home in a few years, you could sell your property while still in the fixed-rate period and never have to worry about the adjustable-rate period.
Keep in mind that these loans have limits on how much the interest rate can increase. There's also a possibility that interest rates will fall once the initial fixed-rate period is over.
Cons of ARMs
ARMs have their fair share of risks as well. For one, your payments could easily increase. If nationwide interest rates rise, your monthly mortgage payments will go up once the adjustable period starts.
It's also possible that not everything will go according to plan. Life happens. Even if you've prepared for the adjustable period, you may still find yourself in a situation where you're unable to make your monthly payment once the interest rate increases.
There is a lot to factor in when considering which type of home loan is right for you and your situation. While an adjustable-rate mortgage comes with a lower initial interest rate, your monthly payments will become unpredictable once the fixed period is over. For some people, this unpredictability is not worth the potential savings. Your lender can talk you through all the loan options available to you, so you have all the information before making your final decision.