Pros and Cons of an Adjustable Rate Mortgage
You probably have heard the term Adjustable Rate Mortgage better known as an ARM. There is nothing difficult to understand regarding this unconventional mortgage. It certainly has its place in the marketplace. But whether it is for you or not, is another discussion. So sit back and we will walk you through this sometimes confusing type of mortgage opportunity.
How an Arm Works
Unlike a conventional mortgage where you make even payments throughout the lifetime of the mortgage, the adjustable rate mortgage can change. Usually every year your payment can change based upon the current market rates. There is much to consider here. But just assume that the rate will adjust upwards. We have been in such a lower interest period for many years. Some say that rates have to go up. And they seem to be. How much it can go up, and when it starts to all depend on the type of ARM and your lender.
There are types of CAPS. How much your rate an go up each year, over the lifetime of the loan, and how much the payment can grow will all be defined before you sign on the dotted line.
Remember that an ARM usually has a lower introductory starting rate than your typical fixed counterpart. Also, it usually will be fixed at this lower rate for a period for years. It can be 5, 7, or even longer in many instances.
If rates do go back down, then your rate will be reset lower. Yes it’s possible your payment can go down.
How an ARM Makes Sense
Now that you know the basics of how the ARM works, the next questions is to determine if this is attractive to you. This largely is based upon your situation. Here are the scenarios where it best fits:
- You only plan on living in your home for a short period of time. This is usually 5 years or less. You can even do an interest only ARM. Similar to renting an apartment, you won’t gain any equity in the home.
- The low introductory rate will lower your mortgage payment. If you are a risk taker or can afford the higher payments (assuming rates go up) then this might make sense.
- The home is in an area with high demand. You are an investor and plan on selling the home and making a profit.
Disadvantages of an Adjustable Rate Mortgage
However, there are clear downsides to this type. This can leave you in financial ruin or worse, without a place to live.
- After the intro period, they can reset (usually once a year). If rates are increasing then your monthly mortgage payment is going to increase. Read the terms of your loan to see how many and how high your rate can go.
- If you plan on selling, you may have to pay a penalty. Yes lenders know that you may sell and they want to be rewarded.
- If you cannot afford the monthly premiums, then you may be forced to sell, or worse, the lender may foreclose on you.