What To Consider Before Taking Out An Adjustable-Rate Mortgage

What To Consider Before Taking Out An Adjustable-Rate MortgageIf you are purchasing a house in the near future, you are probably reviewing your loan options. There are plenty of choices available, and one option is an adjustable-rate mortgage, which is usually shortened to ARM. There are a lot of people who get lured in by the advertisements on ARMs, but are they right for you? There are a few important factors you need to keep in mind.

Adjustable-Rate Mortgages Can Change Your Interest Rate Quickly

First, an adjustable-rate mortgage can change the amount of interest you owe on a home loan quickly. Typically, the ARM has an initial period during which the interest rate will not change. Then, there will be a periodic cap, which is the amount of interest that can be added or reduced to the loan in a set amount of time. There will also be a lifetime cap, meaning that the interest rate cannot rise above a preset boundary.

The Pros of an ARM

There are a few situations where an adjustable-rate mortgage can be beneficial. The biggest benefit is that the interest rate on the ARM is typically lower than the market rate when you take it out. You could get that low interest rate set for anywhere from a few months to a few years. If you plan on selling the house quickly, or if you think interest rates will drop in the future, then an adjustable-rate mortgage could be for you.

The Cons of an ARM

On the other hand, there are a few drawbacks as well. The biggest drawback is that the interest rate on an adjustable-rate mortgage could go up significantly. When this happens, you could end up getting priced out of your house. You might have to sell, or you might foreclose on your home. You need to run the numbers carefully before going with an adjustable-rate mortgage.

Think Carefully About Your Options

In the end, these are just a few of the many points you need to consider if you are thinking about taking an adjustable-rate mortgage. While they can be beneficial in some situations, they also come with a lot of risks. You should talk to a professional before you settle on a loan for your home.

Pros and Cons of Adjustable Rate Mortgages

Pros and Cons of Adjustable Rate MortgagesWhen you are in the market for a new home, you may be faced with numerous options for financing your home. One of the choices you will have to make is whether to apply for a fixed or adjustable rate mortgage. In some cases, an adjustable rate mortgage (ARM) may be your best option, but keep in mind, they are not the answer for everyone.

Adjustable rate mortgages can be risky for some borrowers and it’s important to understand both the pros and cons.

When To Consider Adjustable Rate Mortgages

Perhaps one of the best things about ARMs is they typically have a lower starting interest rate than fixed rate mortgages. For some borrowers, this means it is easier for them to qualify for a loan. ARMs are beneficial for borrowers who:

  • Anticipate an income increase – for borrowers who are anticipating their income to increase over the next year or two, an ARM may be the right option.
  • Will be reducing their debt – those borrowers who have automobile loans or student loans that will be paid off in the next few years may benefit from an ARM which would allow them to qualify for a larger mortgage today anticipating their ability to covert to a fixed-rate mortgage.
  • Are purchasing a starter home – when you anticipate living in a home for five years or less, an adjustable rate mortgage may help you save money for a bigger home.

Adjustable Rate Mortgage Concerns

There are a number of different types of adjustable rate mortgages and they are each tied to specific interest rate indexes. While an ARM may offer borrowers some flexibility in terms of income and debt ratios, the downsides cannot be ignored. Some of the cons of using an ARM to finance your mortgage include:

  • Rate adjustments – borrowers should carefully review their loan documents to see how frequently their interest rates may increase. Some loans adjust annually while other may not increase for three to five years after the mortgage is signed. For borrowers, this means they may anticipate an increase in their monthly payments.
  • Prepayment clauses – oftentimes, lenders include a prepayment penalty with ARM loans which can be surprising for borrowers. Before agreeing to an ARM, make sure you read the documents very carefully to determine how long you need to hold the loan and if there is a prepayment clause.
  • Home values – one of the biggest challenges borrowers face with an ARM is what happens if the property value decreases: Refinancing a home into a fixed-rate mortgage may be more difficult if this occurs.

Borrowers who are searching for the right mortgage should discuss all options with their loan officer. There are specific instances when an ARM may be the best option and there are other times, such as if you plan to stay in your home for more than five years, where a fixed-rate mortgage may be your best option.

Should You Consider an Adjustable Rate Mortgage For Your Home Purchase?

Should You Consider an Adjustable Rate Mortgage For Your Home Purchase?With mortgage rates finally looking like they may move upward a bit as the overall market improves the adjustable rate mortgage starts to come into play again. Better known as the ARM home loan, the adjustable rate mortgage can be a flexible, powerful tool, depending on how it is used.

ARMs Can Help Save On Total Interest Expense

When rates were higher years ago, the ARM was an alternative way to obtain financing for a home without paying as much in interest with every payment. This was ideal for folks who felt that a few years forward the regular market rates would drop or they didn’t plan to stay in the same home for a number of years.

By trading away the mundane predictability of a 30-year fixed loan, the borrower was rewarded with a lower cost loan via an ARM. However, after a short period, anywhere from six month to ten years, the ARM would reset and the rate charged would change to a specific market index.

ARMs became all the rage in the early and mid-2000s as people bought homes to then sell them quickly with rising property values. It was low cost interest paid for large sums of financing, which was then paid back and profits were made just holding a home two years or so and well within the typical ARM period. However, when the real estate market went south a number of years back, many had to hold onto homes longer and rates reset to a higher, floating rate index.

The Advantages of Adjustable Rate Mortgages

Today, the advantage of the ARM again presents itself as rates begin to rise, offering again lower interest rates for home financing for a typical one to ten years. But these tools still include the rate reset after the intro period to consider, and with mortgage rates on an upward trajectory for the next few years it’s worth noting that the loan may cost more when the switch happens.

Thus a borrower should remember to look at the ARM as a shorter-term borrowing tool. A few options that can off-set the potential added interest rate costs in the future are:

 

  • sell the home prior to the reset date while verifying that there is no pre-payment penalty period
  • sell the home for a substantial amount more than it was bought for based on price appreciation or property improvement
  • refinance to a fixed-rate loan at a later date to avoid potentially higher index-based floating rates

 

The same caveat from a decade ago applies to today’s ARMs: they can be extremely valuable for up-front borrowing savings, but borrowers need to always remain aware of the included reset date and what it means for further financial obligations down the line.

As always, talk with your trusted mortgage loan professional to examine the best course of action for your personal situation.