When Does an Adjustable Rate Mortgage Make Sense?
Since the housing meltdown, adjustable-rate mortgages (ARMs) became synonymous with irresponsible lending (and borrowing). Like it or not, adjustable-rate mortgages will once again gain traction.
So what is an ARM? An ARM offers an introductory interest rate period that is lower than what the fixed rate is offering at the time you obtained your mortgage loan. A fixed interest rate is easy to understand as the rate you agreed upon will not change over the life of the mortgage; however an ARM can fluctuate either by increasing or decreasing once the introductory period has expired. Those introductory periods vary as well. Typically the options to choose from on an ARM are 10, 7, 5, and 3-year introductory rates. For example, if you have a 10/1 ARM, your interest rate will not change for 10 years. Once that 10 years has expired, the interest rate can fluctuate (up or down) each year following, thus being called a 10/1 Adjustable Rate Mortgage.
When interest rates are low, oftentimes it only makes sense to lock in at a fixed interest rate, particularly when the fixed interest rate and the ARM introductory rate are priced close together, leaving very little benefit to an ARM. However when interest rates begin to tick upward, that all can change. Typically as interest rates begin to rise, the ARM products become more attractive and drawing the question, “Is an ARM right for me?”
Well, in order to know the answer to this question, you first want to be sure you are working with a mortgage professional who takes the time to explain how an ARM works so you can make an informed decision. You also need to be asked some specific questions, such as, “How long do you plan on living in your home?” For some people, their career may mean periodic transfers around the country (or the world for that matter). In this case, an ARM may be good option. In another scenario, a homeowner may be close to retirement, perhaps within the next 5-10 years and anticipates relocating or maybe downsizing or just paying off their mortgage shortly after retirement.
Lastly, we all know that sometimes life throws us a curve and we aren’t quite where we thought we would be in 5-10 years. This is why it is very important when obtaining an ARM, you are aware of the potential initial interest rate adjustment after the introductory period expires, what cap adjustments apply and not just annually – but for the life of the loan. Some ARMs even allow you to lock the interest rate at certain times. The bottom line is knowing these options means you have educated yourself about ARMs, allowing you to make an informed decision, and this will empower you to use the ARM to your advantage!