When it comes mortgages, you’ve got plenty of options, including an adjustable rate mortgage (ARM). Their competitive interest rates attract plenty of homebuyers, but choosing an adjustable rate mortgage just because of its advertised rate isn’t always a good idea if your specific financial situation doesn’t call for it. On the other hand, this type if mortgage could be the perfect solution for you to realize significant savings.
Before you jump in with both feet, you’d be well-advised to understand the loan terms and how they relate to mortgage rates. Doing so will allow you to determine when it’s best to go with a shorter-term mortgage term adjustable rate mortgage as opposed to a longer-term fixed option.
What Exactly is an Adjustable Rate Mortgage?
An adjustable-rate mortgage (ARM) is basically it’s a home loan with an interest rate that is adjusted periodically to reflect current market conditions. When you agree to an adjustable-rate mortgage, you understand that your rate will fluctuate, as opposed to remaining set as would be the case with a fixed-rate mortgage.
Many ARMs will start off at a lower rate than fixed-rate home loans, and could very well stay the same for a while. That’s typically what grabs the attention of homebuyers. A long-term fixed mortgage rate is generally higher than a short-term adjustable rate mortgage rate because banks are taking on more risk to lend the money for a longer time period.
However, when the introductory period is over, the interest rate will change and your payment amounts will probably increase when the index of interest rates rises because a portion of your rate is linked to this index.
The opposite is also true – if the index of interest rates falls, your payment might go down. While you might be saving some money with lower payments for the first little while, there’s also the chance that your payments might be higher than they would have been compared to a fixed-rate mortgage at some point down the line.
It’s important to keep in mind that this won’t necessarily happen with all ARMs. Some will cap the amount of each adjustment and will set a limit as to how high or low your interest rate can go.
Before you choose an adjustable-rate mortgage, understand how frequently the rate will adjust and find out how high your interest rate can go with each adjustment. In addition, identify how soon your payment could rise, and whether or not there is a cap on how high or low the interest could go,
When is it a Good Time to Opt For an Adjustable Rate Mortgage?
Aside from the initial attraction to a lower introductory interest rate, it’s important to decide if it’s the right time for you to go with an adjustable rate mortgage for your home.
For starters, this specialized type of mortgage is best suited for those who aren’t planning on staying put in their current home in the near future. If that’s you, perhaps an ARM is the right option. That’s because the savings of an ARM can be significant while it’s in the introductory or “teaser” period.
Once the mortgage’ adjustment period starts, on the other hand, savings can be slashed or disappear altogether. If you plan on selling before that introductory period expires, you can take your savings and run before any unfavorable adjustments are made to the interest rate on your mortgage.
To illustrate, let’s say you are taking out a $250,000 mortgage. If you were to take out a 30-year fixed-rate home loan at a rate of 4.01% (the rate as of mid-November 2016), your monthly mortgage payments would be $1,190. Instead, if you took out a 5-year adjustable rate mortgage at the rate of 3.39%, your monthly mortgage payments would be $1,104, which would save you $5,160 over the 5-year term.
There’s definitely the potential to save quite a bit of money with an ARM during the teaser period. However, if you are planning on keeping your current mortgage for a lot longer than 5 years and there’s talk of interest rates increasing soon, you might want to lock in at today’s currently low rates with a longer term fixed-rate mortgage.
The Bottom Line
Going with an adjustable-rate mortgage can certainly be a fantastic way to benefit from mortgage rates that are lower than current market rates. However, the timing has to be right for you. Make sure to speak to an experienced mortgage broker to find out if an adjustable rate mortgage makes sense for your particular situation.