In the past, choosing a mortgage meant settling for what you could afford or finding the best deal on a fixed-rate loan. Today, more lenders and homebuyers are taking advantage of adjustable-rate mortgages (ARMs). This is because ARMs offer many advantages over traditional fixed-rate loans. So how do you know if an ARM is right for you? It all depends on your financial situation and goals as well as your comfort level with risk.
What is an Adjustable-Rate Mortgage?
An adjustable-rate mortgage (ARM) is a mortgage where the interest rate can change over time. ARMs can be fixed or variable, with the latter allowing for periodic changes in an interest rate based on an index such as the prime rate. ARMs are often used to get a lower initial interest rate, which can help make up for other types of risk that come with the loan and may not be reflected in your monthly payment.
Pros of Adjustable-Rate Mortgages
- You can take advantage of lower interest rates.
- You can take advantage of higher interest rates.
- You can still make your monthly payments even if you miss a payment or two.
Cons of Adjustable-Rate Mortgages
One of the biggest disadvantages of an adjustable-rate mortgage is that your payment can increase. Under conventional plans, a fixed-rate mortgage's interest rates do not change over time but with ARM plans, they do. That means if you have an adjustable-rate mortgage and interest rates increase, so will your monthly payments.
In addition to that, if you have an ARM plan and interest rates go down (as they have been doing recently), then your monthly payments may also fall. This means that when it comes time to refinance or sell your home—or even just pay off the loan early—you may find yourself stuck with a higher balance than expected because of the lower interest rates at the time.
Fixed vs. Adjustable-Rate Mortgages
Fixed rate mortgages (FRMs) are more expensive in the short term, but a better deal in the long term. The reason for this is that they get their name from a fixed interest rate that stays constant over the life of your loan.
FRMs are typically offered at lower rates than ARMs, and therefore require you to pay higher monthly payments initially. They also have higher closing costs due to more fees being associated with them as compared to ARMs. On top of all that, you'll have to pay taxes on your upfront cost when taking out an FRM! However, if you plan on staying put for a while—say 5 or 10 years—then buying with an FRM can save you quite a bit of money down the road since any appreciation in value will be yours alone once it's paid off (your lender won't have any stake).
Pros of Fixed Rate Mortgages
Here are some of the benefits of fixed rate mortgages:
- Interest rates. Fixed rate mortgages have lower interest rates than adjustable-rate mortgages. This means that you will pay less in interest each month, and as a result, your monthly payments will be lower.
- Closing costs. The closing costs for a fixed rate mortgage are generally lower than those for an adjustable-rate mortgage because there is no need to adjust them over time (or at all). As such, buyers can expect to save thousands on closing costs when they choose a fixed rate mortgage instead of an adjustable one.
- Qualification requirements and risk tolerance levels are also usually more favorable when it comes to fixed vs adjustable products; meaning if you qualify for one type then chances are good that you'll also qualify for another type!
In short: Fixed-rate loans have their own set of advantages compared with other product types we offer here at Amres.
Cons of Fixed Rate Mortgages
- Fixed rate mortgages are more expensive than adjustable-rate mortgages.
- Fixed rate mortgages have a lower payment, but the savings can be lost because of fees and other costs associated with the mortgage.
- Fixed-rate mortgages typically have shorter terms than adjustable-rate mortgages, so you'll need to refinance your loan or sell before you reach the end of your term if you want to get rid of it.
Considerations for Borrowers
Before deciding on an ARM, consider these factors:
- What are the pros and cons of adjustable-rate mortgages?
- What are the pros and cons of fixed rate mortgages?
- Do you think interest rates will rise or fall? Or both? How much flexibility do you need in your mortgage payments?
Know the ins and outs before deciding on a mortgage.
- Understand the difference between a fixed rate and adjustable-rate mortgage.
- Understand the pros and cons of each.
- If you’re thinking about getting an adjustable-rate mortgage, know what to expect when it comes time to renew your loan.
- Fixed-rate mortgages tend to be more expensive than ARMs, but they’re also more foolproof and predictable.
We hope this blog post has given you a better understanding of adjustable-rate mortgages and how they can be beneficial for your financial situation. If you are still unsure about whether or not an adjustable-rate mortgage is right for you, we recommend reaching out to an Amres lender who can help walk through the pros and cons.