Are Adjustable-Rate Mortgages A Good Option?
Are you looking for a mortgage for your home or car? Delving into the world of borrowing and investing can be intimidating when doing it for the first time.
There are two types of mortgages, Adjustable-rate, and Fixed-rate. In the short to medium term, Adjustable-rate Mortgages, or ARMs, can save borrowers a significant amount of money in interest rates. However, if you still have one when the interest rate resets, you may encounter a much greater mortgage bill.
Let's discuss if ARMs are a good option when the interest rates are high.
What Do Adjustable Rate Mortgages Entail?
The adjustable-rate mortgage is a loan with an interest rate that is fixed at first and then changes with time. Typically, you will pay a smaller fixed interest rate during starting few years. After that period, the interest rate will fluctuate regularly under current market conditions.
When you embrace the mortgage, you will already agree on the time intervals for your low fixed interest rate and any accompanying rate fluctuations. A 10/6 ARM implies you'll pay an interest rate that is fixed for the first ten years; then, the interest rate will modify every six months. A 7/1 ARM, on the contrary, means that you will receive an interest rate that is fixed during the first seven years, after which the rate will adjust annually. Your rate may be higher or lower based on the market conditions.
What Happens When You're In A High-Interest Rate Environment?
In an ARM, the period of time for a fixed interest rate can be the first seven to ten years. As compared to a fixed-rate mortgage, adjustable-rate charges less interest, enabling you to save money during the fixed time.
After the fixed period, you will encounter an adjustable period. The adjustable period will last for the rest of the loan term with varying interest rates. It is worthwhile to note that the interest rate changes at every fixed time, such as six months or even a year.
The market will determine your latest interest rate; if interest rates are low, you will most likely receive a low rate; if interest rates have risen, your new rate will be even higher. However, because most adjustments have caps, your rate will not be able to go above a certain fraction or raise by more than a specific amount during every adjustment.
So, Should You Get An Adjustable Rate Mortgage?
The lower overall interest rate is the most appealing feature of ARMs. An interest rate that is gradually low at the start of the loan may allow you to save some money that can be implemented to the principal, allowing you to pay off your mortgage quicker. In addition, you could be able to finance the more expensive property with lower payments due to the sheer increased cash flow upfront. It may also be advantageous to have additional cash flow in order to gain an advantage in the competitive real estate market.
Many analysts predict that mortgage rates will rise even further this year; due to the varying nature of ARMs. As a result, you have to pay far more than you anticipated. Even minor changes in interest rates can result in hum sum of dollars in additional payments. Returning to the 500,000$ mortgage example, if the interest rate rises by 2% (from 4.12% to 6.12%), the principal and interest payment rise by around 530$/month. So it may be prudent to lock in a cheaper rate now. Of course, you don't want to be on the leash for a rising mortgage rate in the future, but ARMs aren't for everyone.
Things To Consider When Getting Adjustable Rate Mortgages
Learn About the Adjustment Period
Borrowers must understand the basics of ARMs to ascertain whether they are suitable for them. The adjustment time is, in principle, the time between changes in interest rates. Take, for example, an adjustable-rate mortgage with one year of adjustment. The loan would be known as a 1-year ARM and the interest rate; therefore, the monthly loan fee changes once a year. If the adjustment period is three years, the loan is known as a 3-year ARM, and the interest rate changes every three years.
Understand The Rate Change
Borrowers must know the premise for the interest rate change in addition to recognizing how frequently their ARM will adjust. ARM rates are determined by various indexes, the most common of which are one-year constant-maturity Treasury securities, the Cost of Funds Index, as well as the interest amount. Before deciding to take out an ARM, find a lender whose score will be used and research how it has varied in the past.
Prevent Payment Shock
Among the most significant risks that ARM borrowers encounter when their mortgage adjusts the payment shock, which happens when the monthly loan payment increases significantly due to the interest rate adjustment. If the borrower is unable to make the new payments, this can cause hardship.
Keep an eye on the interest rate as the adjustment time approaches to avoid experiencing a shock. Knowing what your adjusted payment will be ahead of schedule will allow you to allocate funds for it, shop around for an improved loan, or seek assistance in determining your options.
A Final Word
Taking out adjustable-rate mortgages is not always a risky venture if you know what is happening when your loan interest rate resets. Unlike the fixed mortgages, which have only one interest rate for the entire loan lifetime, an ARM's interest rate may vary after a certain time and may increase significantly in particular cases. Knowing just how much you'll owe every month can help you avoid payment shock. More importantly, it can assist you in making your monthly mortgage payment.
Don’t be discouraged—we know this list is a lot. That’s why our team at JS is so committed to serving first-time homebuyers. We want to make the home buying experience one that preserves the excitement but sheds the anxiety. We provide clear guidance and advice to help you find the right home, at the right price, in the right neighborhood. Download our FREE planning kit and connect with us today! Let’s go find your first home!