The Pros and Cons of an Adjustable-Rate Mortgage

If you’re looking to buy a home, you might be considering an adjustable-rate mortgage (ARM). An ARM is a loan that typically starts with a lower fixed interest rate compared to a 30-year fixed product for an initial period of the loan. After the initial period, the interest rate can adjust for the remainder of the loan term. Here’s what you should know.

Basics of Adjustable-Rate Mortgages

An ARM usually comes with an initial period of one, three, five, seven, or 10 years. During this time, your interest rate is fixed. However, once that time ends, your interest rate can fluctuate at regular intervals for the remainder of the loan. Your interest rate could go up or down during that time, depending on a benchmark rate index it’s tied to and the original terms of the mortgage.

Pros of an Adjustable-Rate Mortgage

• Initial Lower Rates. An ARM typically has lower initial interest rates than a fixed-rate mortgage. That means you’ll pay less per month than you would with a fixed-rate mortgage during the initial period.
• Options. An ARM might be a wise choice for you if you know you’re not going to live in the house for long. You can take advantage of the low payments and then move before the mortgage starts adjusting.
• Chance of Lower Rates. When your rate starts to fluctuate, there’s a chance it could go down, saving you added cash.

If you don’t plan to stay in a house or apartment for the long-term (more than three to five years) an ARM might be a good choice. Those serving in the military, who tend to move every few years, may benefit from this type of loan.

Another group who might benefit from an ARM are those just getting started in their careers and who expect their income to increase over time. An ARM can make homeownership more affordable at the start of your career, when income is limited, by offering lower upfront costs. For those individuals, the risk of higher payments later may feel more manageable, or they could choose to refinance their loan when they are more established in their career and have achieved a higher credit score. Physicians in residency programs for example may be a good fit for an ARM.

Cons of an Adjustable-Rate Mortgage

• Uncertainty. Once your ARM starts to change its interest rate, you will need to reevaluate your budget to make sure the new monthly payment works for you. While lenders are required to give plenty of notice for rate and payment changes, the fluctuating payment can be hard if you have a tight budget.
• Chance of Higher Rates. Just as you might end up with low rates once the initial period is over, you might get hit with higher rates instead which could impact your monthly payment.
• Planning Doesn’t Always Matter. You might have plans to move on from the ARM before the initial low rate expires, but that doesn’t mean it will happen. Life is uncertain, and you could end up with an ARM for longer than you planned.

Do One Thing: Carefully think through the pros and cons of an ARM and a fixed-rate mortgage before making a choice. Whatever your choice, Fortera is here to help. Visit our Home Loans page to learn more about our Home Loan options.

Original article by Chris O'Shea and adapted in partnership with SavvyMoney.