The Benefits and Drawbacks of Adjustable-Rate Mortgages Explained

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What Is an Adjustable-Rate Mortgage?

An adjustable-rate mortgage (ARM) is a type of home loan with an interest rate that changes over the life of the loan. ARMs start with a fixed-rate period, typically ranging from six months to 10 years, but most commonly three, five, or 10 years. During this initial period, the interest rate is usually lower than that of a comparable fixed-rate mortgage. After the fixed-rate period ends, the ARM switches to a variable rate for the remainder of the loan term, known as the adjustment period.

Pros of an Adjustable-Rate Mortgage

ARMs offer several advantages that may benefit you, depending on your financial situation.

Lower Initial Payments

ARMs generally offer lower interest rates during the fixed-interest period compared to similar 30-year fixed-rate mortgages. This can result in lower mortgage payments, making homebuying more affordable.

Flexibility for Short-Term Borrowers

If you plan to keep your property for only a few years, an ARM can help you keep borrowing costs lower before you sell the property. However, be aware that some lenders impose hefty prepayment penalties, which may offset any savings.

Potential for Lower Interest Rates

Since mortgage rates are tied to an index and adjust periodically, your interest rate and payments may decrease if the index rate falls. This can make your monthly payments more affordable over time.

Cons of an Adjustable-Rate Mortgage

While ARMs have their benefits, they also come with some downsides.

Monthly Payment Can Increase

Although ARMs may have an interest rate adjustment cap, your mortgage rate and monthly payments can still increase. If you’re not prepared for higher payments, this could strain your budget.

May Require a Larger Down Payment

The minimum down payment on a conventional ARM is typically higher than with other types of mortgages. Some fixed-rate mortgages require as little as a 5% down payment, while government-backed mortgages like FHA ARMs may require only 3.5% down.

Refinancing Can Be Costly

Refinancing an ARM to a fixed-rate mortgage can incur significant closing costs, which can run into the tens of thousands of dollars, depending on the size of your loan.

Adjustable-Rate Mortgage vs. Fixed-Rate Mortgage

When comparing an ARM with a fixed-rate mortgage, it’s essential to do the math. Calculate how much each loan will cost you during the initial fixed-rate period and consider potential future rate increases.

Is an ARM a Good Idea?

An ARM may be worth considering if you’re looking for a lower-cost alternative to a fixed-rate mortgage. However, if you prefer predictability, a fixed-rate mortgage might be a better option.

Should You Refinance an ARM to a Fixed-Rate Mortgage?

If you choose an ARM, you can refinance to a fixed-rate loan after the initial rate expires. However, refinancing comes with closing costs and fees, so it’s essential to time your refinancing when rates are low.

Good Credit Can Help You Obtain a Low Mortgage Rate

Having good or excellent credit can help you secure a lower mortgage rate. Check your credit report and score to understand where your credit stands and learn tactics for raising your credit score.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. Our team is here to help you find the best mortgage solution for your needs.

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