Here are the advantages and disadvantages to consider for borrowers who want an ARM.
Pros
Lower Introductory Interest Rates
ARMs typically offer lower introductory interest rates than fixed-rate mortgages. During the initial fixed-rate period, which can range from 1 – 10 years, the interest rate on an ARM is typically lower than the prevailing rates for fixed-rate mortgages. This lower rate results in lower monthly mortgage payments during the initial period.
Due to the lower introductory interest rates, ARMs provide borrowers with lower initial monthly payments than fixed-rate mortgages. This way, homeowners have freed-up funds for other expenses or savings.
Lower Interest Rates
Likewise, your ARM’s interest rate could remain low after the introductory period. For example, say your initial rate expires after 5 years. If market conditions drop interest rates below what you received when you first bought your home, your monthly payment lowers.
An ARM’s lower initial monthly payments allow borrowers to allocate their income toward other expenses or financial goals. This flexibility benefits individuals with competing financial priorities, such as paying off high-interest debts, saving for education or retirement or investing in home improvements. As a result, borrowers have more financial freedom to manage their financial situation.
Ability To Refinance
Another advantage of ARMs is the potential to refinance the loan before the introductory rate expires. Refinancing can enable borrowers to secure a fixed interest rate, providing them stability and predictable payments for the remainder of the loan term. As a result, borrowers who refinance their ARM can shield themselves from variable rate increases several years down the line.
Cons
Interest Rates Could Change
One drawback of ARMs is that the interest rates fluctuate over time. After the initial fixed-rate period, the interest rate on an ARM is adjusted periodically based on changes in the chosen financial index. Therefore, borrowers risk receiving rising interest rates. If market conditions or the index value increases, the interest rate on the ARM can also rise, potentially resulting in higher monthly mortgage payments.
Less Stability
Unlike fixed-rate mortgages, ARMs lack the stability of a constant interest rate throughout the loan term. The uncertainty associated with changing interest rates can create financial challenges for borrowers. Specifically, rising interest rates can inflate your future mortgage payments to the point of unaffordability. This drawback can make budgeting and financial management more difficult, particularly for individuals with fixed incomes or tight financial constraints.
The Monthly Payment Could Increase
One of the significant drawbacks of adjustable-rate mortgages is the potential for the monthly mortgage payment to increase. As the interest rate adjusts, the monthly payment changes accordingly. If the interest rate rises, borrowers may experience an unexpected and substantial increase in their monthly mortgage obligation. Depending on your loan balance, even a rate change of less than a percent can increase your monthly payment by one hundred dollars or more.
Monthly payments might increase: The biggest disadvantage of an ARM is the likelihood of your rate going up. If rates have risen since you took out the loan, your payments will increase when the loan resets.
Monthly payments might increase: The biggest disadvantage of an ARM is the likelihood of your rate going up. If rates have risen since you took out the loan, your payments will increase when the loan resets.
If you sell the home or pay off the mortgage before the adjustable rate goes up, you'll save money. But an ARM probably isn't the right option if you plan to settle in for many years and want the certainty of a constant mortgage rate and monthly payment. In that case, a fixed-rate mortgage is the way to go.
Pros: You get a lower interest rate, you save a lot of money, and you discharge the debt faster.Cons: The monthly payments are much higher. A variable-rate mortgage (also called an Adjustable Rate Mortgage, or ARM) has an interest rate that rises and falls based on market rates.
You can refinance an ARM loan and by doing so, you'll replace your existing mortgage with a new one. In this case, it can be either another ARM or a fixed-rate mortgage.
If you're a homeowner aged 62 or older, a reverse mortgage can help you obtain tax-free income, allowing you to stay in your home, pay bills, supplement your income and more. A reverse mortgage isn't free money: The borrowing costs can be high, and you'll still need to pay for homeowners insurance and property taxes.
It'll 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 who plan to sell their house and move before the rate adjusts to a potentially higher level.
Refinancing can be done for many reasons, but switching from an adjustable-rate mortgage (or ARM) to a fixed-rate mortgage is one of the most common. The general rule of thumb is that refinancing to a fixed-rate loan makes the most sense when interest rates are low.
The main difference between ARMs and fixed-rate mortgages is that ARMs have an interest rate and monthly payments that can go up and down over time, whereas fixed-rate mortgages have an interest rate that never changes, so the monthly principal-and-interest payments stay the same.
The popularity of a fixed-rate mortgage is because many people appreciate the predictability of this financing option. Keeping the same monthly payment means you don't have to worry about the market causing drastic changes to what you pay. A fixed-rate loan makes it easier to create and stick to a budget.
These loans offer lower interest rates than their fixed-rate counterparts but are considered riskier. While they can be fixed for up to 10 years, they eventually adjust to an unknown future market rate.
ARMs offers come with substantial risks, such as higher rates due to interest rate changes in the housing market. Your first adjustment might only raise your monthly mortgage payment a little bit. Subsequent adjustments can put pressure on your financial situation.
Adjustable-rate mortgages (ARMs) come with an interest rate that changes at predetermined times, such as once a year. The rate can go up or down depending on economic factors. ARMs typically have a low introductory rate, which translates to more affordable monthly mortgage payments initially.
One of the significant drawbacks of adjustable-rate mortgages is the potential for the monthly mortgage payment to increase. As the interest rate adjusts, the monthly payment changes accordingly.
A 5/1 adjustable-rate mortgage (ARM) is a type of home loan worth considering if you're looking for a low monthly payment and don't plan to stay in your home long. For the first five years, 5/1 ARM rates can be lower than 30-year fixed-rate mortgages.
Some ARMs, especially interest only and payment options, charge fees if you try to pay off the loan early. That means if you decided to sell your home or refinance it, you will pay a penalty on top of paying off the balance on your loan.
With lower initial interest rates, ARMs can benefit some borrowers in the short term. A starting low rate means you pay a smaller monthly payment against your total loan amount. ARMs offers come with substantial risks, such as higher rates due to interest rate changes in the housing market.
Forecasters believe mortgage rates may fall further in 2024, meaning it may be wise to opt for a variable rate or tracker mortgage for the time being, and fixing your mortgage once rates do slide. For a more accurate steer, it's a good idea to engage a mortgage advisor when you're ready to choose a mortgage.
Is an ARM riskier than a fixed-rate mortgage? Yes. An ARM comes with a greater risk of a higher monthly payment if rates are higher in the future. That long-term risk, however, comes with the reward of a lower monthly payment during your intro period.
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