Have you ever dreamed of buying your dream home — but worried about the heavy monthly payments?
Do you know that there is a way in which you start with lower payments and may save large amounts of money, especially in the early days of your loan?
If you want to save some money upfront and remain flexible, then Adjustable-Rate Mortgages (ARMs) surely are a diamond hidden in some corner.
Unlike fixed-rate loans, ARMs can offer you a lower initial rate — but they also come with their own risks.
In this WeCredit blog we will discuss adjustable-rate mortgages, the various types, and their pros and cons, so that you can determine which might suit your financial journey.
What is an Adjustable-Rate Mortgage (ARM)?
An adjustable-rate mortgage is a type of mortgage loan when a Mortgage loan can also adjust in the interest rate after a fixed-rate period.
ARMs typically offer an initial lower interest rate than fixed-rate mortgages, and that appeals to many borrowers.
In the period where the interest rate is fixed, an ARM will adjust periodically afterward to a benchmark interest rate or index with a margin from the lender. In short, you may pay less or more, depending on the length of time the note is in place.
Types of Adjustable-Rate Mortgages
There are several different types of ARMs, each designed for different financial needs:
Hybrid ARM (such as 5/1 ARM, 7/1 ARM, 10/1 ARM)
- Pays a fixed interest rate for a certain number of years (5, 7, or 10 years) and then adjusts every year.
- Example: A 5/1 ARM pays a fixed rate for the first 5 years and adjusts every year thereafter.
Interest-Only ARM
- Pays only interest, not principal, for a given initial term.
- Then payments rise to pay interest and principal.
- It can provide extremely low initial payments but greater risk down the road.
Payment-Option ARM
- Provides several payment choices each month: full payment, interest-only, or minimum payment.
- These are sophisticated loans and can result in negative amortization if not handled properly.
Adjustable-Rate Mortgage Benefits
- Low Opening Interest Rates – An adjustable-rate mortgage usually has a much lower opening interest rate than a fixed-rate mortgage, meaning lower initial monthly payments.
- Minimal Possibility for Declining Rate – If the market rates drop, so will your interest rate and monthly payment-no refinancing necessary.
- Most Suitable for Homeowners on short-term plans – Sell or refinance prior to that period and before interest during the period.
- Short-Term Affordability – Initial payments are low, so you can qualify for a larger loan amount or more affordable because of the short term.
Adjustable-Rate Mortgages Drawback
- Interest Rate Risk – After the initial period, your interest rate-and your monthly payment-will increase tremendously.
- Payment Shock – Homeowners are faced with large and sudden jumps in their payments, creating strain on budgets.
- Complex Terms – It gets confusing with ever-changing adjustment periods, rate caps, margins, and indexes.
- Negative Amortization Risk (with some ARMs) – If you make minimum payments on certain ARMs, you could owe more than you originally borrowed.
Key Considerations Before Choosing an ARM
Consider the following questions before you choose an adjustable-rate mortgage (ARM):
- How long do I plan to stay in this home?
- Will I be able to make higher payments if interest rates were to rise?
- What kind of adjustment caps and lifetime caps does the loan have?
- To which index is the loan tied? How volatile is that index?
Answers to these questions should help you determine whether an ARM is the right fit for your financial strategy.
Conclusion
This type of mortgage is also sometimes referred to as a flexible mortgage, which means it is meant for many years, and savings early on, and flexibility may be found while the loan is shortened. However, over time, this creates the risk of increased payments in the future, which again necessitates a good deal of financial planning.
Before committing yourself, read and ensure you know all the terms of your ARM; also draw a clear plan for possible changes in payment.
Such an arrangement might be a great intelligent financial strategy with the right kind of planning!
