Many people find the home of their dreams and want to rush through the process of taking out a mortgage as quickly as possible. However, you never want to agree to a mortgage without fully understanding the terms of the loan. Otherwise, you could end up with some surprises down the road.
Both fixed-rate and adjustable-rate mortgages are popular options, but they have one major difference: the interest rate. With a fixed-rate mortgage, your monthly payment will never change. With an adjustable-rate mortgage, it fluctuates.
Let’s take a closer look.
What is an Adjustable-Rate Mortgage?
An adjustable-rate mortgage, often referred to as an ARM, is a type of loan given to purchase a home or other property. As its name suggests, the interest rate will adjust every now and then. Payments, in turn, will go up or down.
It is common for an adjustable-rate mortgage to start out with an interest rate that is lower than other types of loans, including a fixed-rate mortgage. This always makes it seem like the better option.
An ARM will keep this initial interest rate for a while before it adjusts in one direction or the other. As a result, your monthly mortgage payment will then increase or decrease for a period, and you won’t know which way it is going to go until it happens.
The adjustment period is the time between changes in interest rates. Depending on the specifics of the loan, the interest rate can change monthly, quarterly, bi-annually, annually, every 3 years, or even every 5 years. This means your payments can go up or down for the duration of the period.
Is It a Good Idea to Get an Adjustable-Rate Mortgage?
Is an adjustable-rate mortgage a good idea? Why choose this type over a fixed-rate mortgage?
An adjustable-rate mortgage can be a great idea for the right person. Because they often start off with a low-interest rate, they can save you money right away. For those who are just getting started – and plan to be making more money soon – this can be a great idea.
It is worth noting that interest rates are incredibly unpredictable. They may go up for a few years and then trend downward for a few years. You just don’t know so you must be prepared either way.
Types of Adjustable-Rate Mortgages
Did you know that there is more than one type of adjustable-rate mortgage?
Hybrid
Hybrid adjustable-rate mortgages are considered the traditional ARM. They will initially have a low-interest rate for a few years before it begins adjusting itself annually. In other words, it may increase or decrease each year.
Interest-Only
Interest-only adjustable-rate mortgages are those that require the borrower to only pay interest for a certain time. Then, following that period, the borrower will be paying toward both principal and interest.
Payment-Option
Payment-option adjustable-rate mortgages allow the borrower to select their own payment schedule. These can be trickier than you’d imagine. For instance, if you find yourself in negative amortization, your lender may require you to make very large, exorbitant payments.
How Do Adjustable-Rate Mortgages Work?
Each adjustable-rate mortgage comes with a name that consists of two numbers, such as # / #. Believe it or not, this quickly gives you an idea of their terms. The first number will tell you just how many years you will get to pay using that low introductory rate whereas the second number lets you know how often the interest rate will adjust.
Here are a few examples:
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A 3/6 ARM means that you will pay the initial low-interest-rate payment for the first 3 years and then for the next 27 years it will adjust every 6 months.
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A 3/1 ARM means that you will pay the initial interest rate for the first 3 years and for the remaining 27 years of your loan you will pay based on the interest adjustment annually.
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A 5/6 ARM will give you a low initial interest rate for the first 5 years of your loan. Then, for the following 25 years, the interest rate will adjust every 6 months.
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A 7/1 ARM will help you maintain low, initial interest payments for 7 years— followed by 23 years of annual adjustable interest.
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A 10/6 ARM allows you 10 years of a low-interest payment based on the initial interest amount. Then, for the next 20 years, interest will be adjusted every 6 months.
Adjustable-Rate Mortgage: The Pros and Cons
As with anything in life, there are pros and cons of adjustable-rate mortgages. For some, these may be the perfect option. For others, not so much. Knowing all the details about them is the only way to make an educated decision about your future home loan. Weigh the good and bad to determine whether or not an ARM loan should be your go-to choice.
The Pros of ARMs
If you choose to take out an adjustable-rate mortgage, you can benefit from:
- A lower interest rate for the first few years. This means lower monthly payments.
- Have extra money for savings or for projects upon move-in to your new property.
- The potential for your interest rate to drop in the future.
The Cons of ARMs
Of course, you will want to be aware of these cons, as well:
- Interest rates may increase and lead to increased payments.
- Complex terms that may be fully understood.
- Payments may become unaffordable.
Is an Adjustable-Rate Mortgage Right for You?
Adjustable-rate mortgages can sound like a great deal during the initial period, but are they the best option for you? Sometimes it helps to discuss your mortgage options with the professionals.
Ahmad Azizi and the entire team of mortgage experts at Option Funding, Inc. can be an essential resource as you embark on your home-buying journey.
Because we have so many mortgage options to offer, we can review your situation and determine whether an adjustable-rate mortgage is the right fit — or if there is a better solution available.
Contact Ahmad today to get started.