Adjustable rate mortgages are less predictable and less common than fixed rate mortgages, which drives some potential borrowers away. But, depending on your circumstances, it could end up really saving you some money—so don’t move on until you’ve looked at the pros and cons.
What Is an Adjustable Rate Mortgage?
Unlike a fixed rate loan, an adjustable rate mortgage (ARM) is a mortgage with interest rates that can change throughout the life of the loan. Fixed rate loans have a set interest rate throughout the life of the loan.
For most ARMs, there is an initial period, from one month to 15 years, during which the rate is fixed, making the loan a hybrid mortgage. After this period, however, the market index and margin determine how your interest rates will change.
For more information on how an ARM works, check out this post from our sister company that answers the question, “How Does an Adjustable Rate Mortgage Work?”
Pros and Cons of an Adjustable Rate Mortgage
Some of the best things about ARMs are the following:
- Possibility of Low Rates – Because ARM rates are designed to reflect a market, they can fluctuate pretty widely. You have the possibility that the market will do well, lowering your rates and saving you money.
- Caps on Payments – Certain rates and payments of your ARM loan may have caps, meaning they may not exceed a certain amount. There can be caps for the first percentage change to your rate, how much it can change each period, and how much it can change over the whole life of the loan.
- Flexibility – For people who want the freedom to sell or move within a few years of getting their loan, an ARM may be a good option. Talk to your lender to be sure there aren’t any penalties for moving or refinancing in the early stages of the loan.
Hybrid ARMs also offer the following benefits in addition to those listed above:
- Low Initial Interest Rate – One of the major attractions to a hybrid ARM is the low interest rate during the initial period of the loan, which is normally between three and ten years. During this period, it is often lower than rates for fixed-rate mortgages. This can be particularly attractive for people who plan to refinance or move after the initial period.
- Ability to Qualify for a Larger Loan – Because of the lower initial rates, you may be able to qualify for a loan amount that you wouldn’t otherwise qualify for. So if you’ve got your eyes on a dream home with fixed-rate payments you couldn’t afford, an ARM might give you the freedom to get into that home.
Some things you should keep in mind about ARMs are the following:
- Possibility of Rising Rates – An ARM is a riskier loan to take on because of the instability of the market, which could then impact your monthly mortgage payments. Because of the changing market, interest rates may rise, and pretty sharply in some cases. You’ll want to be prepared for the possibility of spikes in your payments—you could end up being incapable of making your payments and, in the worst case scenario, default on your mortgage.
- Caps Can Fall Short – Caps can sometimes backfire. Payment caps and interest caps are separate from one another, so if you reach the limit for your monthly payment but the interest rises, you may not have to pay more that month, but you will still owe the amount for the interest, which gets added to your overall loan amount. This addition to your overall balance is called negative amortization.
- Less Stability – Since the payments can change at any time, you will have to be prepared for less stability than what a fixed-rate mortgage would offer. You may see sudden increases in your monthly payments, which can make planning your finances more difficult.
- Prepayment Penalties – Some ARMs may include prepayment penalties. So if you’re planning to move or refinance early on, as many borrowers do, you’ll want to be sure there aren’t any extra fees for doing so.
How to Know If an Adjustable Rate Mortgage Is Right for You
Finding the right loan for your situation depends on your circumstances and qualifications, so you should always speak to different mortgage professionals to find what will fit your specific needs.
That being said, an ARM or hybrid ARM may be right for you if you are in one of the following situations:
- You are planning to leave or refinance a home before or around the end of the initial period (for a hybrid ARM)
- You are very confident that your future income or career will allow you to cover substantial increases in rates
- You want to qualify for a larger loan
- You think the market is going to become more favorable (but you should still be pretty confident that you can make the payments if this doesn’t turn out)
If you start looking into an ARM, make sure to ask your lender about worst-case scenarios. Since ARMs are riskier than fixed-rate loans, you’ll want to understand the possibilities so that you can take on a loan you’re confident you can handle.
Starting the Loan Application Process
As you begin looking for a mortgage and a lender, make sure not to settle on the first offer that comes your way. Rates, terms, and fees can be quite different from lender to lender, so you want to be sure that you go with the best option for your situation, which often won’t be the first offer you receive.
Similarly, explore different types of loans to be sure you find the one that will work best for you. There are many different types of loans to choose from, including VA loans, FHA loans, and jumbo loans. Know that it may take time to find what works for you, but the effort and energy you put into such a huge decision will be worth it.
To Learn More
At Low VA Rates, we understand how overwhelming it can be to find the right loan. We are committed to getting you into the right home with the right loan. Our caring loan officers, underwriters, and processors are here to help you with your unique situation and home needs.
For questions about ARM loans, or to start the loan application process today, give us a call at (866) 569-8272.