What is an Advantage of an Adjustable Rate Mortgage?
Buying a home is a complex process with too many numbers for any one sane person. Buying price, selling price, interest rates, credit scores, all those numbers can be difficult to get a handle on, but you need to know what you’re up against for the best possible home purchase and mortgage.
One very important set of numbers to know during any real estate purchase is the interest on your mortgage, but you also need to know what type of mortgage you’re dealing with to help those numbers make sense.
A common type of mortgage is an adjustable-rate mortgage (ARM), but this transaction can be a tricky one if you don’t know what you’re doing. Let’s learn more about ARMs including what they are, their advantages, drawbacks, and how to secure the best loan with the help of a local real estate professional.
What is an Adjustable Rate Mortgage?
An adjustable-rate mortgage is a home loan in which the interest rate can change over the course of the loan. Like other mortgages, the interest rate is applied to the outstanding balance on the loan.
How Does an Adjustable Rate Mortgage Work?
ARMs normally begin with low fixed-interest terms but can fluctuate after the fixed interest period has ended. For example, an ARM can start with a fixed rate of 4.5% interest for five years, before switching to the adjustable-rate model where the rate can rise or fall depending on market conditions.
Adjustable Rate Mortgage vs Fixed Rate Mortgage
ARMs and fixed-rate mortgages (FRMS) are two of the most common types of mortgages out there. Whereas the interest rate on ARMs can fluctuate after a fixed period, the rate on an FRM stays the same for the life of the loan. FRMs are most advantageous when you plan on paying the mortgage off over a long period.
Why is an Adjustable Rate Mortgage Bad?
ARMs aren’t always the best mortgages due to the varying interest rate. After the starter fixed rate ends after 3-10 years, you have no idea what type of interest you’ll be paying. Your rate could go from 4% to 6% and higher within a period of a few months.
Because of the uncertainly and possible high-interest rates on ARMs, they aren’t recommended for long term mortgages in most cases, but there are situations where an ARM is advisable.
What are Adjustable Rate Mortgages Tied To?
According to Investopedia, ARM rates are tied to one of three indexes, the 11th District Cost of Funds Index, the London Interbank Offered Rate, and the yield on a one-year Treasury Bill. Your ARM rate will rise or fall depending on the three indexes but is more likely to rise than fall.
Why Choose Adjustable Rate Mortgage?
ARMs aren’t very good for home prices past their fixed rate periods but if you think you can pay off the balance before your fixed-rate becomes adjustable, ARMs might be the perfect choice for you. The “teaser” fixed rate on ARMs is normally as low or lower than other fixed interest rates so you can get away with lower overall interest if you pay an ARM off quickly. ARMs also work well if you don’t plan on being in the home longer than the fixed-rate portion of your mortgage.
Advantages and Disadvantages of ARM loans
Advantages of ARM Loans:
- Lower Interest Rates: ARM loans usually come with lower initial interest rates than fixed rate mortgages, which can save borrowers money on their monthly payments.
- Flexibility: ARM loans offer more flexibility in terms of payment and loan length, allowing borrowers to choose the loan term that best fits their needs.
- Lower Cost: ARM loans are generally less expensive than fixed rate mortgages, so borrowers can save money on closing costs and other fees associated with the loan.
Disadvantages of ARM Loans:
- Interest Rate Risk: ARM loans come with a risk of higher future interest rates, which can lead to increased monthly payments.
- Short Term: ARM loans usually have a shorter term than fixed rate mortgages, so borrowers may have to refinance sooner than expected.
- Unpredictability: ARM loans can be difficult to predict, since interest rates and loan terms can fluctuate over time.
Using Real Estate Professionals for Help
Even with a basic overview, deciding between fixed-rate or adjustable-rate and how much for each can be a challenging question. Home purchases are not easy, but a qualified real estate professional can be a great help during the buying process.
Your real estate agent along with other professionals can lay out your financing options and help you compare between different types of rates like adjustable and fixed. By viewing your options with a qualified professional you’ll be more likely to pick the perfect mortgage for your home purchase and budget.
Get Out and Get a Mortgage
To get a home, you need a mortgage, but there are many types of mortgages like ARMs and FRMs. If you plan on paying the loan off quickly or only plan to be in the home during the fixed-rate portion of your ARM, then an ARM is a great choice. Those in it for the long run can use the certainty of an FRM to make sure there are no surprises in the future.
