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Should You Finance with an Adjustable Rate Mortgage?

Interest rates are starting to rise, and with already high home prices, many buyers count themselves out of being able to buy a home. But don’t walk away so quickly!

As you’re calculating what you can afford and how much your monthly mortgage payment might be, you could be making a big mistake by not considering both fixed and adjustable-rate mortgages. Many buyers are conditioned to jump right into fixed-rate loan options. Maybe you’ve heard that adjustable-rate mortgages (ARMs) can’t be trusted because the bank can raise your interest rate. Or maybe you just have no idea what an ARM is.

Adjustable-rate mortgages serve a valuable purpose in the lineup of mortgage options. You just need to understand how they work and how you can use them to your advantage. Look no further for the complete guide on ARMs. We’ve got everything you need to know about them right here.

HOW DOES AN ADJUSTABLE RATE MORTGAGE WORK?

Adjustable-rate mortgages have an initial interest rate that’s locked in for a set period, and that rate is typically lower than their fixed-rate counterparts. After that, the rate gets adjusted at certain intervals. You can easily see the fixed-rate period and the rate adjustment interval in the description of the loan. For example, a 15/1 ARM indicates an initial, locked-in rate for 15 years, followed by a rate adjustment each year after that.

When the time comes for each rate adjustment, your interest rate can increase or decrease based on the current market conditions. You won’t have to guess what “based on market conditions” means, though, because your loan will include an index that your rate adjustments will be based on.

The terms of your ARM will also include rate floors and caps, which place restrictions on how much your rate can vary after your initial fixed-rate period, during each adjustment interval, and over the loan’s lifetime. The rate floor spells out the minimum adjustment that will take place, while the rate ceiling or cap tells you the highest it can go.

WHY ARE PEOPLE HESITANT ABOUT ARMS?

Some people have heard bad things about adjustable-rate mortgages from their parents, family members, or friends. Part of that hesitation comes from the 2008 housing crisis, when ARMs contributed to the market collapse. At that time, adjustable-rate mortgages were loosely regulated with potentially high rate adjustments. Fast-forwarding to today, there are many more consumer protections in place, helping to make ARMs a safer and more affordable option for homebuyers.

Oftentimes, buyers don’t understand the protections built into them, like the initial fixed-rate period, set adjustment intervals, and caps on rate changes. We encourage you to research the ARM options you’re considering and see how they stack up to other loan programs out there. You should also talk with your loan officer about all the loan options available to you before settling on a final decision.

WHEN YOU SHOULD FINANCE WITH AN ARM

There are many situations when financing with an ARM may be a great choice.

If you are likely to relocate or move to another home during the fixed-rate period of the ARM, it’s a great opportunity to take advantage of a lower interest rate with low risk. The average length of time American homeowners lived in their home before putting it up for sale in 2021 was six years and three months. If you financed your home with a 15/1 ARM, you would have nine years beyond that average to sell, refinance, or even take advantage of more favorable market conditions.

ARMs are also a great option to help you pay down other debts by keeping your mortgage payments low. If you have student loans or other bills, you can pay those down during the initial fixed-rate period of your ARM loan. This is possible because your mortgage payments will likely be cheaper with an ARM compared to what they would be a comparable fixed-rate loan.

These are just two common scenarios that showcase the benefits an ARM can provide. Your loan officer is the best person to run by any ideas and questions you have as you decide on the right mortgage program for you.

HOW AN ARM SAVES YOU MONEY

Here comes the fun part! Let’s look at how you can save money with an ARM.

The low interest rate of your ARM may help you build equity faster. A lower interest rate means you’re paying more towards your principal. That means that you’ll have more equity in your home compared to if you had financed with a fixed-rate loan with a higher interest rate.

Rates can decrease with market shifts, and if they go down, so will your monthly payments. Opponents of ARMs usually highlight that rates will increase during your adjustment intervals, but rates fluctuate with the economy and market conditions. As we’ve seen in the past couple of years, rates can also go down dramatically. And if they go down at your rate adjustment interval, that will result in savings to you.

Consider the amount of time you’ll most likely live in this home. If you’re buying your forever home, you might still be better off to finance with an ARM, but you may consider refinancing after the fixed-rate period. But, if this is your first home, or you might move to another city or house during that initial rate period, you’ll most likely be better off utilizing an ARM than a comparable fixed-rate loan.

Choosing the right type of mortgage for your home purchase is a big decision. It’s one that you should seek expert assistance with. You have to take into account your personal financial situation, comfort with market changes, and how long you plan to stay in the home you’re buying. These factors, plus many more, will come together, helping you decide on the best loan option for you. Connect with our team of loan experts for a free consultation today.