An adjustable rate mortgage or ARM is a home loan with an interest rate that can change periodically. Monthly payments can go up or down based on the current interest rate. The initial interest rate is lower than a fixed rate mortgage but after a certain period, interest rates and monthly payments can go either higher or lower based on federal interest rates. So, are they a good idea, bad idea, or does it depend?
The obvious advantage of an adjustable rate mortgage is that they can carry lower interest rates during the first fixed period of the loan. This could be lower than a conventional fixed interest rate. This can make a huge difference in a monthly mortgage payment for a specific time. For instance, a 30 year fixed rate mortgage, which does not vary can carry a mortgage payment of let’s say $1000 per month while an ARM may require a mortgage payment of $800 a month. Of course, it depends on the purchase price of the property and the current interest rates, but it could save you a few hundred dollars per month.
However, after that fixed period of time is completed the rates can go up or down and if they go up, you may find yourself requiring more monthly mortgage payments than you can afford. This is actually what got most people into the subprime mortgage bust in 2007 and 2008. These adjustable rate mortgages sounded great at the time, but then when the fixed time frame was up, people could no longer afford the inflated interest rates.
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But can rates go down?
We always look at the negative side of the situation and assume prices will go up, but they can go down to. If the rates go up during the fixed timeframe you can feel great that you got a lower rate at the time, but if they go down, you can simply refinance and negotiate for a better deal. So does that mean it’s a win-win in any case?
Here’s a little rule of thumb, on a fixed rate mortgage, if rates go up you can simply enjoy your locked in lower rate. If rates go down, you might consider refinancing to a lower rate, if it makes sense financially.
If you have an adjustable rate mortgage and the rates go up, you might need to consider refinancing to a fixed rate mortgage, but again, that can cost money in closing costs. If the rates go down, simply enjoy the lower interest rate on your mortgage and you don’t have to do anything.
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So when does it make sense to apply for an adjustable rate mortgage?
It’s true that ARM’s can be risky but it’s ideal for people that might only be living in a certain area for a short amount of time either for a work assignment, school, or other reason. You might consider taking out a five-year adjustable rate mortgage if you plan on selling the home within 2 to 4 years. If your income is limited for a short period of time but you know it will increase later, and adjustable rate mortgage might be ideal as you can refinance later or opt for a three-year ARM and take advantage of lower initial payments understanding that you will probably pay more starting in year four.
I’m not going to tell you that adjustable rate mortgages are all doom and gloom because they do have their place. The key is to understand the next 5 to 10 years of homeownership and determine what works best for you now and in the future. If you’d like to stay in a home for at least 5 to 10 years, a fixed rate mortgage might be the best. If you’re considering moving or adjusting your income or even refinancing down the line, taking the benefit of a lower interest rate now might be the best option.
Give me a call and let’s go over some numbers to find out which option works the best for you. 949-600-0944
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