When Does an Adjustable-Rate Mortgage Make Sense?

Sometimes when I offer a mortgage that comes with adjustable rates, I can see my clients shaking their heads and wondering why. Why would I suggest the straightforward, steady payment option that comes with the likes of a fixed-rate mortgage rather than a loan that is subject to market fluctuations?

Here are a few of the reasons why adjustable-rate mortgages (ARMs) can be attractive to some buyers:

1. Low Introductory Interest Rate: ARMs tend to begin with a lower starting rate than fixed-rate mortgages. It offers homeowners the potential to save money in the early months or years.
2. Flexibility: The rigidity of fixed-rate mortgages does not allow for homeowners to take advantage of favorable shifts in the market. If the market rates fall, they are unable to capitalize on the shift. By contrast, homebuyers who elected an ARM reap the benefits of those lower rates.
3. Short-term Savings: Although an ARM can span for 15, 30, and even 40 years, it generally works best in short-term situations. For people who plan on being in their home for less than 10 years, or who are unsure about their living situation and may need to move again soon, the ARM can be a good choice.
4. Cumulative Savings: ARMs can save a homebuyer a lot of money and if the homebuyer has access to high-return investment opportunities, that extra money that is saved can be reinvested or used for other long-term goals that may pay higher returns.

The mix of opportunities to save money while buying a home is a tempting offer to anyone, especially as the reality of the homeownership costs begins to pile up. But it’s important to understand the following about undertaking the responsibility of an ARM loan:

• As your monthly payments continue, they can rise dramatically if there isn’t a cap in place limiting how much they can increase.
• Even though an ARM is designed to respond to the market, it is entirely possible that your mortgage payments will remain the same – and perhaps even increase – even as interest rates fall.

The Basic features of an ARM

An ARM consists of two components: the first is the initial rate and payment, and the second is the adjustment. The first part sets the opening rate for the mortgage and establishes how long that rate will be fixed in place.

For example, let’s say you’re looking into ARMs in Phoenix and you find a lender willing to offer an introductory rate that is competitively set under the 4.38% annual percentage rate for conventional loans. This lender is willing to offer 3%.

Next would be to establish the term, or the amount of time this initial rate would last. This time could range from several months to several years. Let’s say that the lender is willing to offer that 3% for five years on a 30-year loan. Those two numbers together represent an initial rate and payment.

The second component, the adjustment, designates a regular time period in which the rate will adjust, or step. For the sake of making it easy, let’s say that it’s annually. So after the first five years of having a loan with a rate of 3%, the loan will adjust to the market. It could go up, it could go down, or it could remain the same; it all depends on where the market stands at the time of the adjustment.

Adjustable-rate mortgages are not for everyone and it’s important for those potential homebuyers who are considering this type of loan to do their homework and speak with a real estate or financial professional before deciding to make the choice.

If you want to learn more about it, call me at (602) 456-2195 or email me at dkteam@reasyfinancial.com. I’m happy to go through the options with you.

Source: Salted Stone