Adjustable Mortgage Rates – Pros and Cons

Understanding an adjustable rate mortgage

Adjustable Mortgage Rates: Pros and Cons

With home loan interest rates at an historic low, many people are rethinking the adjustable rate mortgage. This type of mortgage rate, which is commonly abbreviated as ARM, comes in a few different flavors. Unlike fixed mortgage rates, they fluctuate over time. The majority of homeowners – roughly seven out of ten, according to Bankrate.com – prefer fixed rates for this reason. Although they have traditionally gotten a lot of bad press, ARMs might be worth a second look. At the very least, it is good to familiarize yourself with the pros and cons of the adjustable rate mortgage.

Adjustable Mortgage Rates – Pros and Cons

Advantages

• Pay a lower rate in the beginning. Initially, you can probably expect to pay a lower interest rate with an ARM. If you plan to sell your home within a few years, this can save you a considerable amount of money in the long run. For example, an ARM might make sense for those who frequently relocate due to a job or military service.
• Hang on to your money. Less interest means more money in your pocket. This creates an opportunity to build a savings or invest the money.
• The possibility of rates dipping even lower. With an ARM, your rate is often tied to the market rate. If rates drop, you can end up saving even more money over time.
• Caps provide extra reassurance. There are two types of interest rate caps. Periodic (or annual) caps limit interest rate increases between adjustment periods, which generally occur in a 12-month cycle. Lifetime caps limit rate increases over the loan’s lifetime. 

Despite their benefits, however, adjustable mortgage rates are not without drawbacks. For every advantage, there is a specific disadvantage.

ARM Disadvantages

• Interest rates are vulnerable to market fluctuations. Many home buyers are turned off by the fact that ARM interest rates are directly tied to market ups and down. When rates are low, the only place they can go is up. This makes adjustable rate mortgages unpredictable.
• Big first rate increases. Many ARMs do not include caps for initial annual increases. This first jump often results in a big hike in interest.
• Rates eventually exceed those of fixed rate mortgages. If you plan to stay in your home for more than five years, you will end up paying more in the long run with an ARM than you would with a fixed rate mortgage.
• Higher refinancing costs. If you start out with an ARM and wish to refinance later, it will probably cost you quite a bit. In the past, many homeowners unable to afford their ARMs ended up losing their homes to foreclosure because they could not come up with the money necessary to refinance.
• The difficulty of setting a regular household budget. If you like to keep your financial ducks in a row, an ARM may not be for you. Because rates are subject to change, your mortgage payment can rise and fall. This makes it tough to maintain control over your household expenses and regular bills.

Before you buy, it is best to speak with an experienced mortgage broker. An expert can help you weigh the pros and cons of an ARM versus those of a fixed rate.

Drew Patrick Miller