The interest rate for an adjustable-rate mortgage is a variable one. The initial interest rate on an ARM is set below the market rate on a comparable fixed-rate loan, and then the rate rises as time goes on. If the ARM is held long enough, the interest rate will surpass the going rate for fixed-rate loans.
ARMs have a fixed period of time during which the initial interest rate remains constant, after which the interest rate adjusts at a pre-arranged frequency. The fixed-rate period can vary significantly—anywhere from one month to 10 years; shorter adjustment periods generally carry lower initial interest rates. After the initial term, the loan resets, meaning there is a new interest rate based on current market rates. This is then the rate until the next reset, which may be the following year.
If you are considering an ARM, you should run the numbers to determine the worst-case scenario. If you can still afford it if the mortgage resets to the maximum cap in the future, an ARM will save you money every month.
An ARM may be an excellent choice if low payments in the near term are your primary requirement, or if you don’t plan to live in the property long enough for the rates to rise.
For people who have a stable income but don’t expect it to increase dramatically, a fixed-rate mortgage makes more sense. However, if you expect to see an increase in your income, going with an ARM could save you from paying a lot of interest over the long haul.
Low payments in the fixed-rate phase: A hybrid ARM offers potential savings in the initial, fixed-rate period. Common ARM terms are 3 years, 5 years, 7 years and 10 years. With a 5-year ARM, for example, your introductory interest rate is locked in for five years before it can change. That gives you five years of predictable, low payments.
Flexibility: An ARM can be a good idea if your life is likely to change in the next few years — for instance, if you plan to move or sell the house. You can enjoy the ARM’s fixed-rate period and sell before it ends and the less-predictable adjustable phase starts.
Your payments could decrease: If interest rates fall and drive down the index against which your ARM is benchmarked, your monthly payment could drop.
Your payments could increase: If interest rates rise, your payments will increase after the adjustable period begins; some borrowers might have trouble making the larger payments.
Things don’t always go as planned: ARMs require borrowers to plan for when the interest rate starts changing and monthly payments grow. Even with careful planning, though, you might be unable to sell or refinance when you want to. If you can’t make the payments after the fixed-rate phase of the loan, you could lose the home.
When choosing a mortgage, you need to consider a wide range of personal factors and balance them with the economic realities of an ever-changing marketplace. Individuals’ personal finances often experience periods of advance and decline, interest rates rise and fall, and the strength of the economy waxes and wanes. To put your loan selection into the context of these factors, consider the following questions: How large a mortgage payment can you afford today?
- Could you still afford an ARM if interest rates rise?
- How long do you intend to live on the property?
- In what direction are interest rates heading, and do you anticipate that trend to continue?
If you are considering an ARM, you should run the numbers to determine the worst-case scenario. If you can still afford it if the mortgage resets to the maximum cap in the future, an ARM will save you money every month. Ideally, you should use the savings compared to a fixed-rate mortgage to make extra principal payments each month, so that the total loan is smaller when the reset occurs, further lowering costs.
Like with all other Mortgages and loans, a Loan Officer can help you get Pre-Approved for a loan so the lending process can happen smoothly. Water Mortgage is here to help with all your Pre-Approval needs!
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