An adjustable rate mortgage (ARM) is exactly what it sounds like. It starts out with a low fixed-interest rate for a period of three to 10 years. However, once this term expires, your loan is susceptible to periodic rate adjustments.
This is in contrast to a fixed rate mortgage with an interest rate that remains the same for the life of the loan.
Tip: If you want your monthly payment to remain the same for the term of your mortgage, an adjustable rate loan isn’t the right choice.
Pros of an ARM
Adjustable rate mortgages remain common because of the many benefits associated with them.
- Low payments during the fixed-rate period: Early on, your payment is likely to be lower than with a fixed rate mortgage. For example, if you have a 5/1 ARM, you know what your interest payment and rate will be for the first five years.
- Flexibility: Do you have plans to sell your home before your rate adjusts? If so, an ARM is a good idea. This allows you to take advantage of the low rate for a predetermined period of time, while avoiding the higher rate that comes into play later on.
- Your payment could decrease: You shouldn’t count on this happening, but it’s possible that your payment could decrease if interest rates fall. This positions you to save even more money.
Cons of an ARM
Just as there are benefits of an adjustable rate mortgage, there are also potential drawbacks. These include but are not limited to the following.
- Your payment could increase: Just as your payments can decrease, they also have the ability to increase. Since this is a concern, make sure you know if there’s a cap on your adjustable rate mortgage.
- Prepayment penalty: While not always the case, some adjustable rate mortgages have a prepayment penalty. So, this makes it more difficult to sell your home or refinance the loan before reaching the adjustable rate period. Be sure to ask about the prepayment fee before securing an ARM.
- Complex to understand: A fixed rate mortgage is simple to understand. Your interest rate remains the same for the term of your loan. But with an ARM, you have to take into consideration the structure of the loan, fees, and rules.
With a handful of pros and cons, don’t jump into an adjustable rate mortgage until you know exactly what you’re getting.
If you’re sure that this is the right choice for you, receive several ARM quotes from reputable lenders. This will help you decide what to do next.