Adjustable rate mortgages (ARMs) have interest rates that change over time. These rates typically start out quite low for 5 to 7 years (sometimes slightly more or less) and then go up over time as the market demands. They’re designed for short-term borrowers or those looking for very low up-front loan costs.
How does an Adjustable-rate Mortgage Work?
Adjustable rate mortgage products typically come in 3/1, 5/1, 7/1 and 10/1 terms. This essentially means your initial rate is locked for either 3, 5, 7 or 10 years. After that point, the interest rate can fluctuate for the entirety of the loan, until the balance is fully paid off or you choose to refinance.
ARM loans are designed for short-term buyers, and the shorter the initial lock-in period is, the lower the initial interest rate will be. For example, if you choose a 3/1 adjustable rate mortgage over a 7/1 loan, you’d enjoy lower interest rates at the beginning of your loan, though those rates could change starting in year four. With the 7/1 mortgage, on the other hand, your rates – though slightly higher – would remain consistent until year eight of the loan.
If you choose an adjustable rate loan, make sure your know the terms of your mortgage. Is there a cap on your interest rate? When and why would it change? If it does hit its cap, could you still afford it? In the event your rate does go out of budget, refinancing can be a great way to lower it, as well as your monthly payments. Check out Benefits of Refinancing to learn more about the refinancing process and when (and why) you might want to do it.
Pros and Cons of an Adjustable-rate Mortgage?
The main advantage of an adjustable rate mortgage is the low up-front costs it comes with. Compared with fixed-rate loans, they can offer significant savings in interest over the first few years of the loan. Still, those rates are subject to change, so unless you plan to move or refinance before that happens, you can likely expect those interest payments to increase over time. This can make it hard to budget for your monthly mortgage payment, regardless of how reliable and consistent your income is.
Is an Adjustable-rate Mortgage Right for You?
Adjustable-rate mortgages are best for homebuyers who:
- Plan to stay in their home only a few years
- Need low up-front monthly payments
- Want low interest rates at the outset of their loan
They’re not ideal for buyers who:
- Need to budget for their monthly mortgage payment
- Have unreliable or fluctuating income
- Plan to stay in their home for the long-term
- Want consistent, reliable rates and payments for the entirety of the loan