When mortgage interest rates are higher, as they have been considered throughout all of 2023, adjustable-rate mortgages become more popular choices among homebuyers.
Unlike traditional fixed-rate mortgage loans, an adjustable-rate mortgage, often referred to as an ARM, features interest rates that can rise or fall over time. The benefit is that an ARM will boast an initial interest rate that is lower than what you’d get with other mortgages until your loan adjusts. However, once the initial period is over, your rate could increase or decrease, meaning you could end up paying more or less each month than what you might have spent on a fixed-rate mortgage payment.
ARMs could be a good way to save money in an environment of high interest rates. But there are potential pitfalls: Your mortgage payments could jump once your loan’s fixed period ends and its interest rate adjusts. Make sure you can afford the new payment that comes with your loan’s potentially higher interest rate.
Because of the fluctuating interest rates, ARMs require more planning than do traditional fixed-rate mortgages. If you are prepared to pay more, though, once your loan’s rate adjusts, an ARM could be a sound financial decision.
An adjustable-rate mortgage is a loan with an interest rate that will change throughout its life. You can take out an ARM in a variety of lengths, but some terms may be better than others in certain situations and markets.
But whatever term you choose, your ARM will come with two periods.
First, there’s the fixed-rate period. During this time, your loan’s interest rate will not change. The fixed period will vary depending on your loan, but most fixed periods last 3 – 10 years. The initial interest rate will typically be lower during this period than what you’d get with a fixed-rate loan. That’s the main selling point of an ARM: Homeowners will have a lower rate and lower monthly payments during this fixed period. But then, the potential savings depends on the market.
After the fixed period ends, your loan will enter its adjustable period, which will last until you pay off your loan, sell your home or refinance your mortgage. During this period, your interest rate will adjust according to whatever economic index it’s tied to. Usually, your interest rate will rise once the fixed period ends, which will also cause your monthly mortgage payment to increase.
How often your ARM’s interest rate adjusts varies depending on the type of loan you’ve taken out. Most ARMs, though, adjust once a year, meaning that your loan’s interest rate can only rise or fall once every year throughout the adjustable period.
The biggest difference between an adjustable-rate mortgage and a fixed-rate mortgage? An adjustable-rate mortgage has an interest rate that can rise or fall over time. In a fixed-rate mortgage, the interest rate never changes.
This means that the principal and interest portion of your monthly payment with a fixed-rate mortgage doesn’t change. However, your monthly payment could change slightly if you pay property taxes and homeowners’ insurance into an escrow account because those payments rise or fall.
The interest rate you get with a fixed-rate mortgage will be the same on the last day of your loan as it was on its first. This rate, though, will typically be higher than the initial rate you’d get with an adjustable-rate mortgage.
An ARM is more of a gamble than a fixed-rate loan. Borrowers hope that their loan’s interest rate doesn’t rise so much during its adjustable period that it negates the savings they’ll enjoy during its fixed period. Many homeowners take out ARMs when they plan on selling their home within 7 – 10 years. Others plan to refinance into fixed-rate loans when their ARMs are set to enter their adjustable periods.
