Advantages and Disadvantages of an ARM (Adjustable Rate Mortgage) Loan

Some home buyers use adjustable-rate mortgage (ARM) loans when buying a home. They do it to save money, because an ARM typically starts off with a lower interest rate than a fixed-rate home loan. That’s one of the advantages. But there are certain disadvantages that go along with these products as well. So let’s look at both sides of the story.

To begin, keep in mind that the perfect mortgage product for you depends on your specific situation and long term goals and those are probably different from the goals and circumstances of your friends and family. For some people, the adjustable-rate mortgage is the perfect mortgage because it can save them a great deal of money.

An ARM is a mortgage that offers an introductory mortgage rate — known as “teaser rates” — for up to the first 10 years of a loan. After the teaser or fixed period ends, the loan’s mortgage rate adjusts annually to reflect current market conditions.

Advantages of an ARM loan

Banks offer low mortgage rates during the initial period In exchange for you accepting a mortgage rate that can change.

So, when does it make sense to choose an adjustable-rate mortgage over a fixed?

If you don’t plan to live in your home “forever”, choosing an ARM over a fixed-rate loan can provide you with huge money savings.

It does not make financial sense paying for a higher 30-year rate if you’re plan to sell and move in 5 to 7 years.

Disadvantage of an ARM Loan

What makes an adjustable-rate mortgage unique is the fact that the interest rate will adjust periodically after the fixed “teaser” period. You’ll know in advance when and how often it will adjust, because the lender is required to tell you those things. But the amount it changes could be an unknown variable. After all, nobody can predict what interest rates will do in the future, at least not with total accuracy. This is the primary disadvantage of using an adjustable-rate mortgage, the uncertainty they bring.

During the first few years of an ARM’s repayment term, you’ll probably have a lower rate than you would if you used a fixed mortgage. That’s the primary benefit of using an ARM. But what would happen to your monthly payments if the rate rose by, say, half a percentage? What if it went up by a full one percent? Could you still afford the payments? These are the kinds of things you must consider when using an adjustable loan to buy a house.

One percent might not seem like much on paper. But when you plug it into a mortgage calculator, you can see how significant it becomes, in terms of the monthly payment. So if you are considering an adjustable-rate mortgage, think about the long term. If you plan to stay in the home and hold the loan for many years, make sure you have a plan for when the rate adjusts. Or consider using the fixed-rate home loan instead.

THE TAKE AWAY

Here’s what you should take away from this article. ARM loans offer benefits up front (during the initial period) in the form of lower interest rates. But they are full of uncertainty later on, and this can lead to unpleasant financial surprises. If you understand this concept, and you plan to sell or refinance during the fixed period years, an ARM might be the best option for you.

But if you’re not comfortable with the uncertainty of rate and payment adjustments, or if you plan to stay in the home for many years after the introductory period, you might be better off going fixed.

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