The Return of Adjustable-Rate Mortgages: Risks and Rewards
The mortgage industry is constantly evolving, and one trend that has been gaining traction in recent years is the return of adjustable-rate mortgages (ARMs). These loans, which have interest rates that can fluctuate over time, were once seen as risky and played a major role in the housing market crash of 2008. However, with interest rates at historic lows and demand for housing on the rise, ARMs have made a comeback. In this article, we’ll explore the risks and rewards of these unique loan products and help you understand if an adjustable-rate mortgage is the right choice for you.
The Basics of Adjustable-Rate Mortgages
Adjustable-rate mortgages are home loans with interest rates that can change at predetermined intervals. Typically, ARMs start off with a fixed interest rate for a set period of time, usually 5, 7, or 10 years. After this initial period, the interest rate can adjust annually based on the current market conditions. Depending on the loan terms, the interest rate may have caps on how much it can increase or decrease each year or over the life of the loan.
One of the main appeals of ARMs is that they usually have lower interest rates during the fixed-rate period, making monthly payments more affordable. This can be especially beneficial for homebuyers who plan to sell the property before the fixed-rate period ends or for those who expect their income to increase in the future. However, once the loan enters the adjustable rate period, monthly payments can increase, and borrowers may face higher interest rates and larger payments.
Pros of Adjustable-Rate Mortgages
Lower Initial Interest Rates
The biggest advantage of ARMs is that they typically have lower interest rates compared to fixed-rate mortgages. This can result in significant savings, especially for those who plan to stay in the home for a short period of time.
Flexibility
ARMs offer more flexibility compared to fixed-rate mortgages. With a fixed-rate loan, your interest rate and monthly payments will stay the same for the life of the loan. ARMs, on the other hand, offer the potential for lower monthly payments during the fixed-rate period and the opportunity to take advantage of lower interest rates in the future if rates drop.
Potential for Savings
If you purchase a home during a time when interest rates are high, an ARM can save you money in the long run. As interest rates decrease, so will your monthly payments. However, if rates increase, your payments will also go up.
Cons of Adjustable-Rate Mortgages
Potential for Higher Payments
As mentioned earlier, the biggest risk with ARMs is the potential for higher payments in the future. While monthly payments may be lower during the fixed-rate period, they can significantly increase once the loan enters the adjustable rate period.
Uncertainty
Because the interest rate of an ARM can fluctuate, it’s hard to predict what your payments will be in the future. This makes budgeting and planning for future expenses difficult. For those who prefer a more stable and predictable mortgage payment, a fixed-rate loan may be a better option.
Refinancing Can Be Costly
If interest rates remain low and you decide to refinance your ARM into a fixed-rate loan, the costs associated with refinancing can add up. These costs can include appraisal fees, origination fees, and closing costs, which can amount to thousands of dollars.
Is an Adjustable-Rate Mortgage Right for You?
Deciding between a fixed-rate and an ARM ultimately depends on your financial situation and future plans. If you plan to stay in your home for a short period of time, an ARM can save you money in the long run. However, if you plan to stay in your home for the long haul, a fixed-rate mortgage may offer more stability and consistency.
When considering an ARM, it’s important to also think about the potential for future interest rate increases and how they may impact your finances. It’s also essential to carefully review the terms and conditions of the loan, including the caps on interest rate increases and how often the rate can adjust. If you are uncertain about your future financial situation, it may be best to opt for a fixed-rate mortgage to avoid any surprises down the road.
The Bottom Line
The return of adjustable-rate mortgages can offer borrowers a chance to save money on their mortgage but comes with some risks. As with any loan, it’s crucial to fully understand the terms and conditions and assess your financial situation before making a decision. Weighing the risks and potential rewards can help you make an informed decision and choose the right type of mortgage for you.
