Adjustable Rate (ARM) Mortgages: Pros and Cons

Select’s editorial team works independently to review financial products and write articles that we think our readers will find useful. We earn commission from affiliate partners on many offers, but not all offers on Select are from affiliate partners.

As mortgage rates soar, more potential buyers are considering adjustable rate mortgages to finance their home purchases.

Variable rate mortgages, or ARMs for short, work differently from fixed rate mortgages, which maintain a constant interest rate for the life of the loan. They can be a little messy at times, so here’s what you need to know about how they work, and the pros and cons of picking one up.

How do adjustable rate mortgages work?

An adjustable rate mortgage is a type of loan that carries an interest rate that is constant at the start but changes over time. During the first few years, you will generally pay a low fixed interest rate. Then, once this period is over, your interest rate will change at certain time intervals depending on market conditions.

The time periods for your low fixed rate and any associated rate fluctuations would already be agreed upon when you accept the mortgage. A 10/6 ARM means you will pay a fixed interest rate for 10 years, then the rate will adjust every six months. A 7/1 ARM, on the other hand, means you’ll get a fixed interest rate for the first seven years, then the rate will adjust every year. Depending on market conditions, your rate may be lower or higher.

Here’s an overview of the pros and cons of choosing an ARM over a fixed rate mortgage.

Advantages

You will pay lower interest rates in the initial mortgage phase

With fixed rate mortgages, you’re locked into the same interest rate for the life of the loan, which is usually 15 or 30 years. But with an adjustable rate mortgage, you start out paying a very low interest rate for what’s called the fixed period.

The fixed period can be the first five, seven or even the first 10 years of your loan. And because you’re usually paying a lower interest rate during this time, compared to what you’d be charged with a fixed rate mortgage, it will help save you money at least for a little while.

Your adjusted interest rates could potentially be lower

After the fixed period, you will enter what is called the adjustment period, which lasts for the remainder of the loan term. This is the part where your interest rate changes at specific intervals, whether it’s every six months or every year.

Your new interest rate will depend on the market — in a low interest rate environment, you’ll likely enjoy a low rate, but if interest rates have risen, your new rate will likely be even higher. It’s important to note, however, that since most adjustments have caps, your rate won’t be able to exceed a certain percentage or increase by more than a certain amount with each adjustment.

Since adjustments are market-dependent, you may end up getting an even lower interest rate than you started with, saving you money while you pay off the loan. .

It will help you save money if you plan to move in a few years

Because this type of loan carries an interest rate that adjusts after the first five to 10 years, it makes it an attractive mortgage option for those planning to sell their home and move before the rate adjusts. at a potentially higher level. This could allow you to make more affordable mortgage payments until you’re ready to move.

The inconvenients

You may struggle with a higher payment once the rate starts to adjust

A huge downside to a variable rate mortgage is that your rate will adjust based on the market, so you may not always know immediately what high or low rate to expect – rate caps, to them, will depend on your lender and the conditions described. in your loan agreement.

If you end up with a much higher interest rate during your adjustment period, there’s always the risk that you won’t be able to pay the monthly payments due to the higher interest charges.

If it turns out that you can’t make your payments and you’re worried about losing your home, consider refinancing your mortgage. Similar to refinancing any other debt, this means you’ll be replacing your old mortgage with a new one, ideally with a lower interest rate. Keep in mind that you may also end up with a new balance to pay off as a result. You’ll also want to start the refinance process when your credit score is as healthy as possible so you’re more likely to be approved for the lowest interest rate.

Your financial situation could be radically different when rates change

Likewise, it is always possible that you will encounter life situations that could affect your ability to pay a potentially higher interest rate on top of your mortgage payment. For example, moving to a lower-paying career, receiving a pay cut, or taking time off work to care for family could have a major effect on your financial situation. Or, if you suddenly had to take care of a child (or another child), you’d want to make sure your mortgage payments remained affordable.

You may have to pay a prepayment penalty if you sell or refinance

If you decide to refinance your variable rate mortgage to get a lower interest rate, you could be hit with a prepayment penalty, also known as a prepayment penalty. The same is true if you decide to sell your home before repaying the loan. When you sell your home or refinance at a lower interest rate, it means the lender will essentially miss out on interest charges they would otherwise have received.

Note that not all lenders impose these penalties – carefully read the terms of your mortgage to see if they do if the situation arises.

Where to find adjustable rate mortgages

If an adjustable rate mortgage seems like the best option for you, several lenders offer this type of loan. Chase Bank offers fixed and adjustable rate mortgages, as well as conventional loans, Federal Housing Administration or FHA loans, VA loans, Jumbo loans, and the Chase DreaMaker℠ mortgage program.

Ally Bank is another option if you’re looking for an adjustable rate mortgage. Keep in mind that even though this lender does not offer FHA loans, USDA loans, VA loans, or home equity line of credit (also called HELOC), you can choose from several loan terms ranging from 15 at 30 years old.

hunting bank

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed and adjustable rate mortgages included

  • Types of loans

    Conventional Loans, FHA Loans, VA Loans, DreaMaker℠ Loans, and Jumbo Loans

  • terms

  • Credit needed

  • Minimum deposit

    3% if you continue with a DreaMaker℠ loan

Advantages

  • The Chase DreaMaker℠ loan allows for a down payment of just under 3%
  • Discounts for existing customers
  • Online support available
  • A number of resources available to first-time home buyers, including mortgage calculators, affordability calculator, training courses and home consultants

The inconvenients

  • Does not offer USDA loans or HELOCs
  • Existing customer discounts apply to those with large balances in their Chase deposit and investment accounts

Allied bank

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed and adjustable rate mortgages included

  • Types of loans

    Conventional Loans, HomeReady Loan and Jumbo Loans

  • terms

  • Credit needed

  • Minimum deposit

    3% if you continue with a HomeReady loan

Advantages

  • The Ally HomeReady loan allows a down payment of just under 3%
  • Pre-approval in just three minutes
  • Submission of the application in less than 15 minutes
  • Online support available
  • Existing Ally customers are eligible for a discount that applies to closing costs
  • Does not charge lender fees

The inconvenients

  • Does not offer FHA, USDA, VA or HELOCs loans
  • Mortgages are not available in Hawaii, Nevada, New Hampshire or New York

Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.

Comments are closed.