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Adjustable Rate Mortgages

Flexibility for Your Home Financing Needs

If you’re considering buying a home and expect to move or refinance in a few years, an adjustable rate mortgage (ARM) might be a good choice for you. Here’s what you need to know:

What is an ARM? Unlike traditional fixed-rate mortgages, where your interest rate stays the same, an ARM has a rate that can change over time. Initially, your interest rate is set for a specific period—often 5, 7, or 10 years—after which it can fluctuate based on the market. This means that your monthly mortgage payments could go up or down after that initial period. Many ARMs come with rate caps that limit how much your rate can increase, providing some protection against big jumps in payments.

Who is this for?

Homebuyers Planning to Move or Refinance in a Few Years: ARMs are a good fit for those who expect to sell their home or refinance before the adjustable period kicks in. This makes it appealing for people who aren’t looking for long-term commitments.

Key Features to Consider

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Variable Interest Rates:

An ARM starts with a fixed interest rate for an initial period (commonly 5, 7, or 10 years). After this period, the rate can change based on market conditions. This means your monthly payments can potentially fo up or down.

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Rate Caps:

Many ARMs come with rate caps, which limit how much your interest rate can increase at each adjustment and over the life of the loan. This provides some protection against drastic payment increases.

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Lower Initial Rates:

The initial interest rate on an ARM is often lower than that of a fixed-rate mortgage, leading to lower payments at the beginning of the loan. This can help you save money initially.

Pros:

Lower Initial Rates:

With a lower starting interest rate, you can enjoy lower monthly payments, which can be especially beneficial if you’re on a tight budget or want to maximize your purchasing power.

Flexibility:

If you plan to move or pay off your mortgage within a few years, an ARM can be a flexible choice, as the lower initial rate can save you money during that time.

Potential Savings:

If interest rates fall, your payments may decrease, allowing you to save even more.

Cons:

Payment Variability:

After the initial fixed period, your payments can increase if interest rates rise. This could strain your budget and make it difficult to plan for future expenses.

Complexity:

ARMs can be more complicated than fixed-rate mortgages. It’s important to understand the specific terms, potential fees, and how rate adjustments work before committing.

Things to Keep in Mind

Understanding Terms:

Make sure you fully understand the terms of the ARM, including how often rates adjust and the maximum rates you could face.

Budgeting for Changes:

Be prepared for potential increases in your monthly payment after the fixed period ends. Consider how changes in your payment might affect your budget.

If you have further questions or want personalized assistance, reaching out to a home loan advisor can help clarify your options!

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Frequently Asked Questions

1. What is the formula for calculating an ARM rate?

The ARM rate is calculated by adding the margin to the index value.

Formula: Index + Margin = Fully Indexed Rate

2. How do economic conditions impact my ARM rate?

Since ARM rates are tied to an economic index, changes in the economy, such as interest rate adjustments by the Federal Reserve, can cause the index to rise or fall. As the index changes, your ARM rate may adjust accordingly, affecting your monthly payments.

3. When is an ARM a good choice for homebuyers?

An ARM can be a good choice if you plan to refinance to a fixed-rate mortgage before the adjustable-rate period begins. If you anticipate that interest rates will fluctuate over the first few years of your loan, you can take advantage of a lower initial rate with the intention of refinancing later when rates stabilize or when you’re ready for a longer-term fixed rate.

4. Is an ARM a good option if I expect my income to increase in the future?

If you anticipate that your income will grow by the time your ARM adjusts, it might make sense to go with an ARM. For example, a young professional just starting their career or a student nearing the completion of their doctoral degree might expect a salary increase. However, this approach carries some risk since there’s no guarantee that your income will rise as expected. If your income doesn’t increase, you may find yourself struggling with higher mortgage payments once the rate adjusts. A fixed-rate mortgage offers more certainty because your payments won’t change over time.

5. What if my plans change and I end up staying in the home longer than expected?

While an ARM can be a great shortterm solution, life doesn’t always go as planned. If you stay longer than anticipated, or if market conditions make it hard to sell, you may face higher payments once the rate adjusts. In this case, refinancing to a fixed-rate mortgage is an option, but it’s important to make sure you can still afford the mortgage payments if your ARM rate increases.

30-Year Fixed-Rate Mortgage: The payment on a $200,000 30-year Fixed-Rate Loan at 4.375% and 75.00% loan-to-value (LTV) is $998.58 with 1.875 points due at closing. The Annual Percentage Rate (APR) is 4.635%. Payment does not include taxes and insurance premiums. The actual payment amount will be greater. Some state and county maximum loan amount restrictions may apply.

15-Year Fixed-Rate Mortgage: The payment on a $200,000 15-year Fixed-Rate Loan at 3.75% and 75.00% loan-to-value (LTV) is $1454.45 with 2 points due at closing. The Annual Percentage Rate (APR) is 4.214%. Payment does not include taxes and insurance premiums. The actual payment amount will be greater. Some state and county maximum loan amount restrictions may apply.