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What are Adjustable Rate Mortgages?

Wondering what the difference between Fixed Rate and Adjustable Rate Mortgages (ARMs) are? We’ve got you covered.

 

Fixed Rate vs. Adjustable Rate

It’s important to know what a Fixed Rate Mortgages is before considering an Adjustable Rate Mortgage.

What is a Fixed Rate Mortgage?

Fixed Rate Mortgages have an interest rate that never changes over the term of the loan. With a fixed-rate loan, the principal and interest portion of your monthly mortgage payment stay the same. Although, real estate taxes* and homeowners insurance costs can rise from year to year, they would be the only variable that could change your monthly payment.

Fixed Rate Advantages:
Fixed Rate Mortgages are beneficial for you if your income is not rising rapidly, and you want the comfort of a steady mortgage payment that won’t change. Fixed Rate Mortgages are typically the most popular.

Fixed Rate Disadvantages:
The downside of Fixed Rate Mortgages is that they typically have a higher interest rate than the introductory period of an adjustable-rate mortgage would.

What is an Adjustable Rate Mortgage?
Adjustable Rate Mortgages typically have a lower interest rate during the initial introductory period (commonly 5 or 7 years) than a fixed-rate mortgage would (depending on current market conditions). After the introductory period of an adjustable rate mortgage is over, the interest rate is allowed to rise annually every year after that, determined by the climate of the market.

Adjustable Rate Advantages:
A lower interest rate means a lower monthly payment (during the introductory period). The time frame at which your interest rate will change and payments can rise varies by the program you choose. Adjustable Rate Mortgages are an option for borrowers who will be able to comfortably make larger payments after the introductory period is over – whether that is through expected raises or career path advances in the near future. Adjustable Rate Mortgages are also a great option for people who only plan on living in their new home for a few years, and plan to sell before the interest rate and payment start to increase.

Adjustable Rate Disadvantages:
The trade-off with the Adjustable Rate Mortgage is that, along with typical increasing costs for taxes and homeowners insurance year to year, the interest rate of your monthly payment also increases, resulting in continuous rising payments over the remainder of your loan term, which could hurt your budget. However, if you are planning on selling your home before this introductory period is over, you will not be affected by the possible rise in payments.

Types of Adjustable Rate Mortgages
The most common type of Adjustable Rate Mortgage is a 5/1 ARM. The 5/1 ARM has that lower introductory rate for the first 5 years of the loan term. After the introductory period is over, the interest rate is allowed to change once a year, on the anniversary of the mortgage loan, for the remainder of the mortgage term.

5/1 ARM = “5” year introductory period w/ rate adjusting every “1” year after that – giving you “5/1”

  • 3/1 ARM = 3 year Introductory Period/Rate adjustments every 1 year
  • 7/1 ARM = 7 year Introductory Period/Rate adjustments every 1 year
  • 10/1 ARM = 10 year Introductory Period/Rate adjustments every 1 year

 Is an ARM Right for You?
Now that you know the basics of Fixed Rate Mortgages and adjustable rate mortgages, you will be more equipped to choose which option is best for your situation.

 

Here are a few questions to assist in weighing your options.

How long will you stay in this home?
If you only plan to live in the house for a few years, it could make sense to go with an ARM. Especially since you will never be subject to a huge rate and payment increase, due to you selling your home before the adjustment period begins.

What is the current market like?
When interest rates are on the higher end, an ARM is a great option because of those lower initial rates allow you to pay smaller monthly payments up front. IF rates happen to be falling, homeowners have a probability of their rate going lower, even without refinancing. IF rates are on the rise by the time your adjustment period starts, your monthly payment will increase.

 

When rates are very low, fixed rate mortgages are ideal – ARMs become beneficial when rates are climbing.

Can you afford your mortgage payment if interest rates rise?
ARM monthly payments can fluctuate considerably as annual rate adjustments occur as market climates shift. Depending on the exact rate caps included in your particular ARM product, interest rates can end up rising several percent if you keep the mortgage past the introductory period.

 

Reach out to your local USA Mortgage Loan Originator to chat about if an ARM product is right for you and your unique situation!

*USA Mortgage is not licensed to provide tax advice. Please reach out to your licensed tax advisor for more information.

 

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