Read Time: 5 Minutes|
December 1, 2022
Did you know that adjustable-rate mortgages are becoming more attractive for homebuyers in today's market? To lock in a lower rate, an ARM may be the best solution.
Are you questioning whether now is a good time to buy? Before you write off your homeownership dreams, know that an adjustable-rate mortgage (ARM) could be the home buying strategy that gets you in your new home. Even better, ARMs give homebuyers access to lower-than-average mortgage rates initially; there are more details to uncover about the relationship between rates and ARMs, so let’s start with the basics.
A fixed-rate mortgage is a type of home loan that features an interest rate that stays the same throughout the life of the loan. This means monthly P&I payments stay the same for the length of the loan term, which is commonly 30 years.
An Adjustable-Rate Mortgage (ARM) is a type of home loan with an interest rate that changes (adjusts) throughout the life of the loan. After a pre-determined fixed-rate period, the payment may fluctuate up or down. So, how does it work?
Although it’s called an adjustable-rate mortgage, it’s important to know that there is a fixed-rate period of the loan. This fixed period is where many homebuyers experience their greatest ARM advantage.
When you meet with a lender to discuss ARMs, they should explain that typically, ARMs can be beneficial financially because homebuyers are able to lock in a low mortgage for the first 5, 7, or 10 years of the mortgage. (Remember, the lower the rate, the lower the monthly P&I payment.) But how? ARMs generally offer a lower mortgage rate, compared to a 30-year fixed loan term.
Now you may be thinking, “If the first 5, 7, or 10 years of the loan features a lower rate and lower monthly P&I payments, what do the rates and payments look like thereafter?” Here’s your answer: When the lower, fixed-rate period of the loan term ends (after 5, 7, or 10 years), the interest rate changes periodically throughout the life of the loan. For example, with a conventional ARM, the rate changes every 6 months based on the market at the time.
Depending on a variety of factors like the rate environment and your homeownership plans for the future, ARMs could be an ideal loan type for a variety of homebuyers, including:
Now that you’re familiar with a few different scenarios explaining when a homebuyer might choose a mortgage option that’s known for having variable payments, let’s weigh the pros and cons. One of its most popular attractions is that the initial rate is typically lower than other mortgage options. On the flip side, the variable rate may cause apprehension for borrowers who prefer stable monthly P&I payments.
Switching from an adjustable-rate mortgage (or ARM) to a fixed-rate mortgage is one of the most common reasons to refinance. Refinancing to a fixed-rate loan usually makes the most sense when interest rates are low.
An annual ARM cap is a clause in the contract of an ARM that limits the possible increase in the loan's interest rate during each year. The cap, or limit, is usually defined in terms of rate, but the dollar amount of the principal and interest payment may also be capped. When you speak with your lender, they’ll be able to explain various payment scenarios for you to understand what an ARM could look like for you.
The more you know about ARMs and other mortgage types, the more confident you can feel when making a decision on the right home loan for you. The best piece of advice we can give is to meet with a lender to discuss your finances and homeownership goals. We’re happy to help!
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