Adjustable-Rate Mortgage Can Be A Good Choice

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Why an Adjustable Rate Mortgage Can Be a Good Choice for Savvy Homebuyers

Buying a home is an exciting time of life, but navigating the mortgage world can be daunting. With so many options available, it’s hard to know where to start. As mortgage rates have risen over the last 12 months, many homebuyers are investigating whether an adjustable-rate mortgage can be a good choice.

While fixed-rate mortgages have long been considered the gold standard, they’re not always the best choice. Enter adjustable rate mortgages (ARMs). Don’t let the name intimidate you, even though we haven’t seen many ARMs in the last few years, with historically low rates. An ARM can be a useful tool when rates are higher than we’d prefer.

In this article, we’ll explore how ARMs work, the pros and cons, and why savvy homebuyers are choosing them. Whether you’re a first-time homebuyer or a seasoned buyer, understanding the basics of ARMs could save you thousands of dollars. Even if you don’t end up choosing an ARM, the knowledge about ARMs will help you make a wiser choice. So let’s dive into the world of adjustable rate mortgages and see if they’re right for you.

What is an Adjustable Rate Mortgage (ARM)?

Adjustable rate mortgages, or ARMs, are a type of home loan where the interest rate can change over time. The initial rate is typically lower than a fixed-rate mortgage, but can adjust based on market conditions. This means your monthly mortgage payment can fluctuate throughout the life of the loan. So, why would anyone choose an ARM over a traditional fixed-rate mortgage? Let’s take a closer look at the pros and cons to find out.

The Pros and Cons of ARMs

Adjustable Rate Mortgages, or ARMs, have both advantages and disadvantages. On the one hand, ARMs offer lower initial interest rates than traditional fixed-rate mortgages. This can work out well if you plan to live in your home for a short period or expect your income to increase significantly in the next few years. In addition, if interest rates decrease after the initial period, you may be able to take advantage of the lower rates without having to refinance.

On the other hand, ARMs are riskier than fixed-rate mortgages because your interest rate can increase after the initial period, which can cause your monthly mortgage payment to go up. In addition, if you do not plan to move or refinance before the initial period is over, you may end up paying more in interest over the life of the loan than you would with a fixed-rate mortgage.

Before we do a comparison to see if an adjustable-rate mortgage can be a good choice, let’s review the two types of mortgages and understand our terms.

What is a Fixed-Rate Mortgage?

A fixed-rate mortgage has an interest rate that does not change throughout the life of the loan. It has a consistent monthly payment. On the other hand, an adjustable-rate mortgage has an interest rate that changes (up or down -yes, it can go down) over the course of the loan. An adjustable-rate mortgage may start with a lower rate than a fixed-rate mortgage. However, an adjustable-rate mortgage is typically more complicated than a fixed-rate mortgage and has interest rate caps that limit how much the rate can increase or decrease.

• Fixed rate mortgage: With a fixed rate mortgage, your interest rate is set when you take out the loan and will not change for the life of the loan, typically 15 or 30 years. There are also 20-year and now 40-year mortgages. This means that your monthly mortgage payment will also be the same each month. Fixed rate mortgages offer more predictability and stability, which can be important for borrowers who want to know exactly what their monthly payments will be.
• Adjustable rate mortgage (ARM): With an ARM, your interest rate is not fixed. Instead, it is tied to an index, such as the LIBOR or the Fed Funds rate. This means that your interest rate can go up or down over time, which will also cause your monthly mortgage payment to go up or down. ARMs typically have a fixed-rate period, during which the interest rate is locked in. After the fixed-rate period ends, the interest rate will adjust periodically, based on the index it is tied to. ARMs can offer lower initial interest rates than fixed rate mortgages, but borrowers should be aware that the interest rate could go up significantly after the fixed-rate period ends.

Advantages of Fixed-Rate Mortgage

There are many advantages to a fixed rate mortgage. Here are some of the most important ones:

• Predictability: Your monthly mortgage payment will stay the same for the life of the loan, so you can budget accordingly. This can be especially helpful if you have a variable income or if you are planning for retirement.
• Stability: A fixed rate mortgage provides stability in your financial life. You don’t have to worry about your monthly payments going up if interest rates rise. This can give you peace of mind and make it easier to plan for the future.
• Convenience: A fixed rate mortgage is easier to understand than an adjustable rate mortgage. There are no surprises with your monthly payments, so you can focus on other things. For those of us who are not as sophisticated in their financial knowledge, this can be a big plus.
• Lower interest rates: Fixed rate mortgages typically have lower interest rates than adjustable rate mortgages after the initial period. This can save you money on your monthly payments and over the life of the loan.

In summary, a fixed-rate mortgage offers stability and predictability, making it a good choice for first-time homebuyers. They are available with a variety of terms, including five, 10 and 30 years, and and now, 40-year terms. The 30-year mortgage is the most common type.

Disadvantages of a Fixed-Rate Mortgage

Fixed rate mortgages have some disadvantages, including:

• Higher initial interest rate: The initial interest rate on a fixed rate mortgage is typically higher than the interest rate on an adjustable rate mortgage. However, the interest rate on a fixed rate mortgage will not change over the life of the loan, while the interest rate on an adjustable rate mortgage can go up or down.
• Longer term: The term length of a fixed rate mortgage is typically 15 or 30 years. The longer the term, the lower the monthly payment will be, but you will pay more interest over the life of the loan.
• Closing costs: There are closing costs associated with all mortgages, including fixed rate mortgages. These costs can vary, but they typically range from 2-5% of the loan amount.
• Cannot take advantage of falling interest rates: If interest rates fall after you take out a fixed rate mortgage, you will be locked into the higher interest rate for the life of the loan. This means that you will be paying more interest than you would if you had waited to take out the loan.
• Yes, you can refinance if rates fall: but remember there will be closing costs and other refinancing expenses. Be sure to talk to your mortgage professional to get an accurate idea of what those expenses can be.

If you are considering a fixed rate mortgage, it is important to weigh the advantages and disadvantages carefully. If you are looking for a mortgage with predictable monthly payments and peace of mind, a fixed rate mortgage may be a good option for you. However, if you are willing to take on some risk in exchange for the possibility of a lower interest rate, an adjustable rate mortgage may be a better option for you.

Here are some additional things to consider when choosing whether a fixed rate mortgage or an adjustable-rate mortgage can be a good choice:

• Your financial situation: If you have a stable income and a good credit score, a fixed rate mortgage may be a good option for you. If your financial situation is more volatile, an ARM may be a better option, as you will have the flexibility to adjust your monthly payments if your income changes.
• Your plans for the future: If you plan to stay in your home for a long time, a fixed rate mortgage may be a good option. If you plan to move in the next few years, an ARM may be a better option, as you will not be locked into a long-term loan.
• The current interest rate environment: The current interest rate environment can also affect your decision. If interest rates are low, a fixed rate mortgage may be a good option, as you will be able to lock in a low interest rate for the life of the loan. If interest rates are high, an ARM may be a better option, as you may be able to get a lower initial interest rate.

One disadvantage of a fixed-rate mortgage is that you can’t take advantage of falling interest rates without refinancing. Unlike an adjustable-rate mortgage, there is no lower introductory rate. Another disadvantage is that it could cost more in interest over the life of the loan if you secure the loan at a higher rate and you don’t refinance if rates drop.

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Advantages of an Adjustable-Rate Mortgage

An adjustable-rate mortgage can be a good choice for homebuyers today. Adjustable-rate mortgages (ARMs) can offer some advantages over fixed-rate mortgages, including:

• Lower initial interest rate: ARMs typically have a lower initial interest rate than fixed-rate mortgages. This can make it easier to qualify for a loan and afford the monthly payments.
• More flexibility: ARMs offer more flexibility than fixed-rate mortgages. For example, you may be able to adjust your monthly payments if your income changes. You may also be able to refinance your loan if interest rates drop.
• Potential savings: If interest rates stay low or fall, you could save money on your mortgage payments over the life of the loan.

However, it’s important to remember that ARMs also have some disadvantages, including:

• Interest rates can go up: The interest rate on an ARM can go up after the initial fixed-rate period ends. This could cause your monthly payments to go up, which could make it difficult to afford your mortgage.
• Shorter term: ARMs typically have a shorter term than fixed-rate mortgages. This means that you will have to pay off your loan sooner, which could mean higher monthly payments.
• Closing costs: ARMs typically have higher closing costs than fixed-rate mortgages. These costs can add up, so it’s important to factor them into your decision.
• Interest rate caps: ARMs typically have interest rate caps that limit how much the interest rate can go up each year and over the life of the loan. However, these caps may not be enough to protect you from significant interest rate increases.
• Payment caps: ARMs typically have payment caps that limit how much your monthly payment can go up each year and over the life of the loan. However, these caps may not be enough to protect you from significant interest rate increases.
• Potential for negative amortization: If your monthly payments do not cover all of the interest that you owe on your mortgage, the unpaid interest will be added to your loan balance. This is called negative amortization. Negative amortization can make it more difficult to pay off your loan and can also increase the total amount of interest that you pay over the life of the loan.

If you’re considering an ARM, it’s important to understand the risks and benefits involved. It’s important to carefully consider your financial situation, short-term and long-term goals, and the current state of the housing market before deciding if an ARM is right for you. In the next section, we’ll explore how to evaluate these factors and determine if an ARM is the best option for your homebuying needs. It’s also a good idea to talk to a mortgage lender to get pre-approved for a loan and to compare different ARM options.

Here are some additional things to keep in mind about adjustable rate mortgages:

• Initial interest rate: The initial interest rate on an ARM is typically lower than the interest rate on a fixed rate mortgage. However, the interest rate on an ARM can go up or down after the initial fixed-rate period ends.
• Term length: The term length of an ARM is typically 5, 7, or 10 years. The shorter the term, the lower the monthly payment will be, but you will pay more interest over the life of the loan.
• Closing costs: There are closing costs associated with all mortgages, including ARMs. These costs can vary, but they typically range from 2-5% of the loan amount.
• Interest rate caps: ARMs typically have interest rate caps that limit how much the interest rate can go up each year and over the life of the loan.
• Payment caps: ARMs typically have payment caps that limit how much your monthly payment can go up each year and over the life of the loan.

Fixed Rate Mortgage Vs. Adjustable Rate Mortgage

Here is a table that summarizes the key differences between fixed rate mortgages and ARMs:

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How to Determine if an ARM is Right for You

It’s important to take a thoughtful approach when considering whether an adjustable rate mortgage (ARM) is the right fit for your homebuying needs. After all, an ARM can be a smart way to save money in the short term, but it does come with a higher level of risk. So how do you determine if an ARM is right for you?

1. First, take a close look at your current financial situation. Are you comfortable with the idea of your monthly mortgage payment potentially fluctuating in the future? If not, a fixed-rate mortgage may be a better fit for your needs. Additionally, think about your short-term and long-term goals.
2. Do you plan on staying in the same home for many years, or do you envision moving in the next few years?
3. Finally, consider the current state of the housing market. If interest rates are low and you think they might rise in the future, an ARM could be a smart way to take advantage of those low rates now. By taking these factors into account, you can make an informed decision about whether an ARM is right for you. In the next section, we’ll explore why many savvy homebuyers do choose ARMs, despite the potential risks involved.

Which type of mortgage is right for you depends on your individual circumstances and needs. If you are looking for predictability and stability, a fixed rate mortgage may be a good option for you. If you are willing to take on some risk in exchange for the possibility of a lower initial interest rate, an ARM may be a good option for you.

Why Savvy Homebuyers Choose ARMs

In the previous section, we discussed the factors that you need to consider before opting for an adjustable rate mortgage (ARM). Now, let’s take a closer look at why many savvy homebuyers are finding that an adjustable-rate mortgage can be a good choice.

One of the primary reasons that ARMs are popular is that they offer lower initial interest rates than fixed-rate mortgages. This lower rate can save you a significant amount of money in the short term, especially if you don’t plan on staying in your home for many years. Additionally, if you opt for an ARM during a low-interest rate environment, you can take advantage of those rates before they potentially rise in the future.

Another benefit of an ARM is that it can be a smart choice for buyers who expect their income to increase in the future. As your income grows, you’ll be better equipped to handle higher mortgage payments if the interest rate on your ARM increases. Additionally, if you’re confident that you’ll be able to pay off your mortgage early, you can take advantage of the lower initial interest rate without having to worry about future rate spikes.

Ultimately, the decision to choose an ARM or a fixed-rate mortgage depends on your specific financial situation and goals. By weighing the potential benefits and risks of each option, you can make an informed decision that meets your unique needs as a homebuyer.

Common Advice for Making a Mortgage Application

No matter which mortgage loan product you choose, there are important steps to take in preparation for making a mortgage application.

• Credit scores are still crucial for getting the best loan rates and terms. Before making a loan application, do everything you can to shore up your credit scores. If you see an error on your report, get it corrected immediately.
• Get all your documentation in order and be sure to get it to your lender without delay. If you get the process started before you start looking for a home, you’ll be that much further ahead. It is a huge benefit in a competitive market to approach a seller with an offer with financing that is already approved.
• During the loan process, take extra care of your credit and expenditures. Don’t buy a new car, don’t change jobs, don’t buy new furniture with your credit card…you get the picture. There are a few don’ts during the loan process.

In conclusion

Adjustable rate mortgages (ARMs) can be a smart choice for savvy homebuyers looking to save money and get a better deal on their mortgage. While they may not be the right fit for everyone, exploring the pros and cons and discussing options with a qualified mortgage professional can help determine if an ARM is right for you. Don’t miss out on the potential benefits of an ARM – take the time to make an informed decision and secure the best possible mortgage for your future. As the saying goes, “those who fail to plan, plan to fail.” So plan wisely, and your investment in a new home will be a smart one.

It is important to talk to a mortgage lender to get more information about your options and to get pre-approved for a loan before you start shopping for a home.

Thank you to our lending expert Vince Petrolle, NMLS #532639, with CrossCountry Mortgage, for this helpful information on how an adjustable-rate mortgage can be a good choice for homebuyers in 2023. Vince can be reached at 301-461-1734.

Contact Chris Highland to see homes for sale in Frederick Md. We have been helping buyers and sellers in the central Maryland area for more than 31 years. We’re here to help you navigate through any challenges that the real estate market presents.

Cell:  301-401-5119
Broker:  888-860-7369

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