Is an ARM for you?
Before you move into the home of your dreams, you’ll need to decide what type of mortgage will work best for your financial needs. One type is an adjustable-rate mortgage, also called an ARM. What is an ARM? We’ll explore this kind of loan so that you can decide if it’s right for you. An adjustable-rate mortgage or ARM is a home loan with an interest rate that adjusts over time. These rates are governed by benchmarks such as the U.S. Treasury and are influenced by economic conditions and your credit score. These are unlike a fixed-rate mortgage which keeps the same interest rate and payment for the life of the loan.
If your goal is to get the lowest mortgage rate on a starter home, an ARM is a good introductory option because it usually starts low. Although it is generally lower than a fixed-rate mortgage, a caveat is that the initial interest rate, after the fixed period ends, can fluctuate over time, causing unpredictability of what you will owe on your payments each month. You will have to be prepared financially if the rate goes up. However, it can also go down.
Advantages—An ARM allows you to pay more for the principal during a fixed period. If you anticipate being in your home for no more than five years, an ARM may be your best option. Also, if you’re planning to upgrade to a larger home, the plan will enable you to sell your original house before the interest rate begins to adjust. If you can’t sell your home before the rate changes, you may want to consider refinancing into a fixed-rate or a new adjustable-rate mortgage. There are also rate caps which will allow you more management with each recent rate change because they are limited to how much they can rise.
Disadvantages: The downside is that your interest rate will likely increase after the fixed rate period ends, causing your payments to go up. This increase can cause a feeling of instability and may discourage some homeowners from taking out this kind of loan. In addition, it could be difficult to project how you stand financially when the rates start fluctuating.
Types of adjustable-rate mortgages—The Hybrid ARM starts with a fixed interest rate for 5, 7, or 10 years, then the rate adjusts up or down on a pre-set schedule of your choosing, either once per year or every six months. For instance, if you choose a 5/1 ARM, your rates will begin to adjust yearly after the five years have lapsed. For a 7/6 ARM, your rates will start to adjust every six months after the seven years have lapsed. The most popular is the 5/6 ARM plan.
The Interest-only ARM allows borrowers to pay only the interest for a set period. Once that period ends, the principal and interest are expected to be paid.
The payment-option ARM gives borrowers the most freedom by permitting them to select their own payment structure and schedule equal to or greater than the minimum payment. It can be for a 15, 30, or 40-year term. The downside is that your costs may increase because you need to pay more to cover the interest.
Qualifications—As with all mortgages, ARM loans have several requirements. You have to prove your income with documentation. Your income level and credit score will determine how large of a mortgage payment you qualify for.
When deciding on a mortgage plan, it’s always advisable to examine your long-term home ownership goals. You could be ready to buy your dream home that you want to live in long-term or start to test the waters and enjoy a temporary situation until you are secure enough to upgrade. If you are considering the latter, then an adjustable-rate mortgage is your best plan. Already have an ARM plan and are looking for a change? First, explore rates to see if it’s a good time to refinance to a fixed-rate mortgage. If rates are higher than your current ARM, it’s not the right time to switch.