If you want to make a smart decision when it comes to your home loan, you need to gain an understanding of adjustable rate mortgages (ARM). They can be a little scary to some, and they may not be the right option for you, but they do offer certain advantages and you will never know if they are the right fit unless you take the time to learn a bit about them.
Adjustable Rate Mortgages Offer Many Savings Opportunities
There is one major reason that home owners consider choosing an adjustable rate mortgage: saving money. You can generally getting a lower initial rate from lenders if you choose an adjustable rate mortgage over a fixed rate mortgage. This is because you are taking on some of the risk that would normally be on the lender. Second, there is a chance that rates will drop and you can see a decrease in your interest rate and thus your monthly mortgage payment.
Adjustable Rate Mortgages are Risky
The flip side to adjustable rate mortgages is that they are inherently risky. Your rates may rise when market rates go up, leading to a higher monthly mortgage payment. Not only can this result in more of your hard-earned money going toward interest payments, but for some it may mean the mortgage payments are no longer affordable. This can be worsened by the other carrying costs of a home including homeowners insurance and necessary maintenance. It is not uncommon for homes to be sold or owners to face foreclosure because their ARM jumped too high for the homeowners to make their mortgage payments.
Managing the Risks Associated with an Adjustable Rate Mortgage
There are ways to manage the risks that come with an adjustable rate mortgage. As you shop around for the right lending solution, look for safeguards in place to keep payments under control. First, it is very common for adjustable rate mortgage offers to have an initial period with a fixed rate, usually 3 or 5 years. Also seek out loans with caps or restrictions on how much rates can increase. These will vary based upon the specific loan, but there are usually caps on the amount your interest rates can increase in a specific period of time. There may also be limits on the amount your payments can increase.
What to Look Out For with an Adjustable Rate Mortgage
You need to thoroughly understand any offer before you sign up for a loan. There are so many options and so many ways caps and restrictions can be structured that you can never be too sure about what you are getting. Here are a few important items to focus on.
- Length of fixed rate period
- How much interest rate can increase in a given year
- Total cap on how much interest rate can increase over the life of the loan
- Mortgage payment caps
- Variability in caps from year to year (5% cap one year, 1% cap the next)
When to Choose an Adjustable Rate Mortgage
Making the choice between an ARM and a fixed rate mortgage is a big one. Your own set of circumstances, including current market interest rates will determine which type of loan you should get. If you are purchasing a home or refinancing and interest rates are high, you should strongly consider an ARM. If rates are low, you are facing a higher risk of increasing interest rates and you may need to consider alternatives to an adjustable rate mortgage, such as a fixed rate mortgage. The key is to shop around for the best interest rates and terms while also staying informed of your options.