The adjustable-rate mortgage, often abbreviated ARM, is a mortgage option that many people aren’t familiar with. It often doesn’t even get presented to home buyers as an alternative to the conventional fixed-rate mortgage most new homeowners end up with.
You should understand all of your options before financing a purchase as significant as a house. Let’s shed a little light on how an ARM works, how it can benefit you, and the situations where you’d be better served by a conventional mortgage.
How Does an Adjustable-Rate Mortgage Work?
The answer is right in the name; unlike a fixed-rate mortgage, the interest rate of an ARM changes at set times. You can tell when it will adjust by the mortgage name. For example, GOLD currently offers a 10/1 Adjustable-Rate Mortgage. The first number (10) tells you that the introductory rate remains the same for the first 10 years. The second number (1) is how often the rate can change after the introductory period, in this case, that’s every year. A 5/5 ARM would have a fixed rate for the first five years, then could change every five years after that.
What determines the new interest rate once the introductory period ends? It’s typically a simple calculation of index plus margin, with the index based on something like the Prime lending rate, and the margin is a set amount the lender adds to it. That means your mortgage lender doesn’t just set your ARM rate willy-nilly once you hit the variable rate period of your mortgage.
What’s Good about an Adjustable-Rate Mortgage?
Variable rate loans tend to get you a break on interest, ARMs included. Our 10/1 ARM, as of this posting, has the lowest interest rate we’re offering on any of our mortgage loan options. Most people want the lowest interest rate they can get; if that’s you, you’ll want to check out Adjustable-Rate Mortgages.
While it’s true that no one can predict the future, ARMs aren’t completely unpredictable. You know when it’s going to change and you know what factors affect it (index + margin). Knowing that, lets you plan a little. For example, if you buy a home with the 10/1 ARM, you know your rate won’t change for 10 years. If you have a strong reason to believe you’ll move and sell your home before those 10 years are up, the years (and interest rate) after that are irrelevant. Whether the house you’re buying now is a starter home, you have a career that leads to frequent moves, or you have kids that will all be out of the house in that timeframe, there are plenty of reasons you may be expecting to make a move during the introductory rate period.
Finally, it’s always possible that rates will stay the same, go down, or move up only marginally. In that case, you’ve still got a great rate. Variable rate doesn’t mean bad rate; it just means change.
What are the Cons of an Adjustable-Rate Mortgage?
Well, like I said before, no one can predict the future. Any number of things could happen to throw a wrench in your carefully-laid plans. That move that seemed a sure thing could be put on hold due to a lost job or tight housing market. The current trend of very low rates could change and make your payments higher when the initial rate ends.
Although, even if it does go up, ARMs have a little bit of insurance in the form of a lifetime cap. That’s a limit to how much the interest rate can increase during the life of the loan. Even so, you should make sure that you’re financially prepared for higher monthly payments in the variable period, just in case.
Someone I wouldn’t recommend an adjustable-rate mortgage for would be a retiree with no intention of moving who’s living on a fixed income. In fact, if you’re getting close to retirement age, I’d recommend an aggressive payoff strategy with a shorter-term mortgage of 10 or 15 years with a goal of owning your home free & clear before retiring. But that’s a discussion for another blog post.
Still Not Sure if the ARM is for You?
That’s why we’re here! GOLD’s Mortgage Consultant is your guide start to finish in the mortgage process. We’ll listen to your goals, plans, and financial background to help figure out what mortgage option is the best fit for you. Get in touch and get started: 1-800-641-5036.
About Janet Weinhofer
Jan is the VP of Lending at GOLD. She directs and coordinates all lending activities within the credit union, ensuring compliance with lending policies. She ensures her team provides friendly, professional, timely, and personal service to all our Members. Jan is proud to be part of GOLD’s mission to empower our Members to achieve personal financial success.
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