Should You Consider An Adjustable-Rate Mortgage?

Are you looking for a new mortgage? If you are, you may be wondering if an adjustable-rate mortgage or ARM is the right choice. While they aren't for everyone, they can be a great option for some people. In this blog post, we will discuss the pros and cons of an adjustable-rate mortgage so that you can make a good decision about what is best in your situation.

How does an adjustable rate mortgage work?

An adjustable-rate mortgage or ARM, is a type of mortgage where the interest rate changes periodically based on the market rates.

The initial interest rate on an ARM is often lower than the interest rate on fixed-rate mortgages in the initial period of the loan, which makes your monthly payments lower. Also, an increase or decrease in the interest rate on an ARM could result in increasing or decreasing your monthly mortgage payments after the initial period.

An adjustable-rate mortgage could be a good option for you if you are looking to save money on your mortgage payments, though it is important to keep in mind that ARMs are financial products and they aren't right for everyone.

Advantages of adjustable rate mortgages:

Caps on Rates and Payments

One advantage of adjustable rate mortgages is that they typically come with caps on how high your interest rate can go. They also have limits on how much your payments can increase from one adjustment period to the next. Borrowers benefit from peace of mind knowing that their mortgage payments won't skyrocket if interest rates rise. 

Low Payments in the Fixed-Rate Stage

ARMs often have a lower starting interest rate than fixed interest rate loans. What this means is that your monthly payments will generally be lower during the initial fixed-rate stage of the loan, which is typically 5 years. 

Your Monthly Payments Could Decrease

If interest rates go down during your adjustable period, your monthly mortgage payment could decrease as well and could free up some extra cash each month.  

Flexibility

Adjustable-rate mortgages can offer borrowers more flexibility than fixed-rate loans. With this in mind, if you think you may sell your home before the end of the fixed-rate period, an ARM could save you money on interest payments. 

Disadvantages of adjustable rate mortgages:

While there are many advantages of ARMs, there are some disadvantages to consider as well.

They Are Complex

One of the biggest disadvantages of adjustable rate mortgages is how complex they can be. While there are a lot of variables at play, it can be difficult to understand how all variables work together. It can also make it difficult to predict how your monthly payments will change over time.  

The Interest Rate Could Increase 

Your interest rate will typically start lower than it would with a fixed-rate mortgage and the interest rate will adjust based on prevailing market rates. If market rates have gone up, so will your interest rate and your monthly payments. 

What If Something Unexpected Happens? 

Sometimes unexpected things can throw our financial plans off course. If you lose your job or experience a significant decrease in income, you may struggle to make your monthly payment. And if you're unable to make those payments, you could ultimately lose your home to foreclosure.

As you can see, there are both advantages and disadvantages to adjustable rate mortgages. It's important to weigh all of the factors before deciding if an ARM is right for you. A good place to start is by asking yourself these questions below.

How high of a mortgage payment can you afford?
It's important to ensure you'll be able to afford your payments if interest rates rise. This is why it's a good idea to get pre-approved for a mortgage so that you know how much house you can afford. Additionally, it's important to have a buffer in your budget for emergency situations so you can still make your mortgage payments if rates go up and your income stays the same.

Do you see interest rates rising or falling?

What do you think interest rates are going to do? If you think interest rates are going to fall, an ARM could be a good choice since your payments will likely go down as well. However, if you think rates are going to rise during the initial fixed-rate period, a fixed-rate loan may be a better choice since your payments could go up. This is also something that you should speak with a financial advisor about before making a decision. 

Will you live on the property?

If you're planning on living on the property for five years or less, an ARM might make sense since you won't have to worry about higher payments down the road. If you plan on living in the property for seven years or more, however, a fixed-rate mortgage might be a better choice since your payments will stay the same throughout the life of the loan.

Another point to consider is how much risk you're comfortable with. If you start to get anxiety with the thought of your interest rate potentially going up, then a fixed-rate mortgage may be a better option for you—even if it comes with a higher interest rate initially. However, if you're willing to take on a bit more risk in exchange for the potential to save money in the short term, then an ARM could make sense. Either way, be sure to weigh all of the potential risks and benefits carefully before making a decision. 

Summary

Adjustable rate mortgages can offer homeowners several advantages, including caps on rates and payments, low initial payments, the potential for lower monthly payments initially and more flexibility than fixed-rate loans. If you sell your home or plan to pay off the mortgage before the adjustable rate increases, you'll save money.

If you're considering an adjustable-rate mortgage, talk to your lender about all the risks and benefits involved.

Valley Strong Credit Union is Federally Insured by the NCUA and is an Equal Housing Lender.