Buying a home doesn’t have to cost an ARM and a leg upfront. When it comes to financing your property purchase, there are many types of mortgages available, one of which comes with particularly low initial payments.
Today I’ll be covering the topic of adjustable rate mortgages (ARMs), as well as their advantages and potential pitfalls.
What is an ARM or adjustable rate mortgage?
Adjustable rate mortgages, sometimes referred to as variable-rate mortgages or tracker mortgages, differ a bit from your standard home loan. The main (& most important) difference- their adjustable interest rate.
This means that over the duration of paying off your mortgage, it’s likely that the interest rate will periodically fluctuate. This will affect the amount of your monthly payments and will depend on the index (a benchmark that reflects the general condition of the market) and a margin (a percentage determined by the lender and agreed on during the application process).
Why go with an adjustable rate mortgage?
You may be wondering why you’d want to take the gamble with an adjustable rate mortgage, but there are some advantages to the borrower.
- It’s common that ARMs start with lower monthly payments and interest rates than fixed or capped rate mortgages.
- If the index, or general mortgage interest rate decreases, or even remains the same, you could end up paying back less than you would have with a fixed-rate mortgage.
- Adjustable rate mortgages work with a cap structure, meaning that there is a limit on how much your rate can change within a given period of time.
What to watch for when applying for an adjustable rate mortgage.
While there are some advantages to taking out an adjustable rate mortgage over a loan with a fixed rate, there are also some things to keep in mind.
Before signing the dotted line, here are some things to consider:
- Your mortgage interest rate, and therefore your monthly payment, can, and is likely to, change. If your monthly payments increase, will you be able to afford it? How much of an increase can you afford?
- When you take out an ARM, you are the one taking the risk that interest rates could eventually rise or fall. When you take out a fixed rate mortgage, that risk falls on the bank or financial institution that provided the loan.
- Depending on the type of ARM you agree on, the change in your monthly payments may not reflect changes in general mortgage interest rates- increases and decreases. All adjustable rate mortgages have different terms, so make sure to thoroughly read the fine print.
- The interest adjustment period with most ARMs also differ, so make sure you know ahead of time. Some have rates that change as often as every month, while some only adjust every 5 years.
- You could encounter penalty fees for paying off your mortgage early to avoid higher interest payments in the future.
- When applying for your mortgage, be sure to ask your lender about the type of index being applied to your loan. Usually the type of index applied is simply a formality, meaning the adjustments made will be very similar, but the type of index can end-up affecting the amount of your monthly payments.
Looking to learn more about the ins and outs of ARMs? Contact me today to get in touch with a trusted lender.