What is an adjustable-rate mortgage?
An adjustable-rate mortgage (ARM) is a home loan with an interest rate that can vary over the life of the loan. These loans offer a low rate for a specified period of time and then switch to a floating rate that fluctuates along with a designated rate index. Therefore, if you have an adjustable-rate mortgage, your monthly home loan payments will remain the same for a given number of years, and then can go up or down depending on market conditions at the end of the term.
What is the difference between an adjustable-rate mortgage and a fixed-rate mortgage?
When you borrow money to purchase or refinance a home, you can choose between a fixed or adjustable interest rate. While the mortgage interest rate can vary with an adjustable-rate mortgage, with a fixed-rate mortgage, it will remain the same over the life of the loan. Because your interest rate won’t fluctuate if you have a fixed-rate mortgage, your monthly payments will remain the same throughout the loan term.
Borrowers who have fixed-rate mortgages appreciate the predictability of knowing what their monthly payments will be over the duration of the loan. However, if rates drop, they may feel they’ve missed out on a better deal. ARM rates will often be much lower than the fixed rate mortgage initially, and the opportunity to possibly have a reduced rate at the end of their term appeals to some.
How does an adjustable-rate mortgage work?
Adjustable-rate mortgages can be more complex and riskier than fixed-rate mortgages, so it is important to go into the process of getting an ARM Rate loan with an understanding of how this type of loan works. There are various rules, fees, structures, caps, and penalties with ARMs, so you must do your due diligence to understand the agreement.
For the first period of an adjustable-rate mortgage, the interest will be fixed. After this initial period ends, the rate will change periodically, based on a particular index. So, a 3/1 ARM will have a fixed interest rate for three years. Then, once the three-year period has ended, the rate can change each year thereafter according to the rate index, plus a fee, or margin.
What are some types of adjustable-rate mortgages?
Lenders offer various types of adjustable-rate mortgages, including 10/1 ARMs, 7/1 ARMs, or 3/1 ARMs, in which the first number represents the number of years in the fixed period and the second number means the rate will be adjusted each year. There are also 5/5 ARMs, which have a five-year fixed rate and are adjusted every five years and 7/6 ARMs, which have a seven-year fixed-rate and are adjusted every six months.
Is an adjustable-rate mortgage right for me?
If you’re wondering whether an adjustable-rate mortgage is right for you, consider a few factors:
Current market conditions: Currently, most new home loans happen to be fixed-rate mortgages. This is because interest rates have been at historic lows, and buyers want to take advantage of those low rates over the long term. Adjustable-rate mortgages grow in popularity when interest rates are higher. That’s because when rates are high, borrowers can often get a lower rate up front with an ARM. Borrowers also believe it may be worth taking a risk on an ARM that rates will drop in the future, and they’ll be able to take advantage of lower rates during the variable period.
Financial situation: If this is your first time buying a home, or if you are finding it challenging to get a fixed-rate mortgage because of your finances, it may be easier to get an adjustable-rate mortgage. An ARM could also be a good choice if you are a borrower who has a strong financial situation and you are confident you will be equipped to handle fluctuations in your monthly mortgage payment a few years down the line.
Future plans: If you plan to own your home for only a few years, you could take out an ARM and aim to sell the home before the fixed-rate period expires (make sure there’s no penalty for doing so). It is important to remember that plans change, so do housing markets, and you may not be able to sell your home when you intend to.
Whether you choose an adjustable or fixed-rate home loan is a personal decision with many variables. Doing your research can help ensure you find the loan that’s right for you, so compare lenders, loans, and rates to find the ideal mortgage.
At Neat Loans, we offer fixed and ARM rate loans. Check out today’s rates and view the income and assets often needed to qualify.
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May 20, 2022
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