With the changing rate environment, some have wondered about whether an Adjustable Rate Mortgage (ARM) is a better alternative to the traditional fixed-rate mortgage loan. Here are some tips to help you decide if an ARM would be right for you.
As with any loan, it is important to balance the risk against the reward. ARMs typically come with a lower initial rate that is variable, meaning it can go up if a certain index rate increases, but only to a certain level, and usually with caps on how much it can go up at a time. So with that uncertainty, how to decide if it is more to your advantage than a fixed-rate loan? Ask yourself the following questions:
- How long are you going to stay? Generally, if you plan to move out of a home within a few years, you are more likely to benefit from an adjustable rate mortgage loan.
- Which bank has the best features? Some ARMs may have a fixed rate for 10 years before the interest rate can change, others may reset after three. One may be better for you than another, depending on your circumstances. Also, the maximum rate increases during the interval and the life of the loan can be different from one lender to the next. Some lenders “discount” the initial rate of the ARM, which means that your payments are likely to increase A LOT beginning with the first reset period (when the 1st rate adjustment takes place).
- Am I OK with the loan payment if the rate soars to its highest level while I still own the home? Your lender has to disclose the worst-case scenario with respect to rates, so assess the implications of that situation. Remember to factor the possibility of increasing property tax and insurance, because while your income may not increase, the property expenses probably will.
There are other factors to consider when evaluating whether an ARM represents a good opportunity. Your lender can help you decide which loan type makes the most sense, too. The FDIC has a helpful resource on its website, along with links to additional information. Read “The Comeback of the Adjustable Rate Mortgage” or to get the audio recording of the text.