The demand for adjustable-rate mortgages (ARMs) is on the rise as interest rates on conventional home loans surge, leading many to explore more affordable options for buying a home.
Last month, the average interest rate on a 30-year fixed mortgage hit 8%, reaching its highest level since August 2000. In contrast, rates on the average ARM currently range between 7.12% and 7.65%, according to Bankrate.
While ARMs can be an attractive choice, they aren’t suitable for everyone. If you’re considering an adjustable-rate mortgage, here are three essential questions to ask:
1. What Different Types of ARMs Could I Apply For?
Adjustable-rate mortgages usually come in four forms: 3/1, 5/1, 7/1, or 10/1. These numbers refer to the fixed-rate period of the loan. However, there are two crucial elements to pay attention to with ARMs—the fixed-rate period and the floating-rate period.
The fixed-rate period signifies how many years your interest rate will remain unchanged. On the other hand, the floating-rate period determines how often your mortgage rate will change. During this floating-rate period, your mortgage rate could either increase or decrease based on the prevailing interest rates.
For example, a 5/1 ARM means that the mortgage rate remains locked for the first five years, and after that, it changes every six months based on current rates. Conversely, a 10/1 ARM implies that the mortgage rate remains fixed for a decade and adjusts annually based on current rates after that initial period.
2. Is an ARM an Ideal Option for Me?
An ARM can be a great choice for someone planning to sell their property during the fixed-rate period. Additionally, individuals with unstable income sources that fluctuate frequently might find an ARM more suitable, as suggested by the National Association of Realtors.
However, ARMs are not the best option for those seeking a consistent monthly mortgage payment. Due to the way interest rates fluctuate during an ARM, borrowers might face significantly higher mortgage payments at times when it may be challenging to afford them.
For instance, someone using a 5/1 ARM on a $394,000 home (the median home price for September, according to NAR) with a 20% down payment would pay approximately $2,891 a month for the first five years at today’s 8% interest rate. However, if interest rates were to rise to 12% in 2028, the mortgage would surge to $3,720.
3. Will I Save Money with an ARM?
In the short term, yes. The fixed-rate period of an ARM typically comes with a lower interest rate than what someone would pay for a conventional home loan. However, long-term savings are not guaranteed.
The uncertainty lies in future interest rates, particularly during the floating-rate period. While borrowers might continue to enjoy lower-than-average payments depending on current rates, they must be prepared to handle higher monthly mortgage payments if interest rates suddenly increase after the ARM’s fixed-rate period.
Adjustable-rate mortgages can be a wise financial choice, but understanding the different types of ARMs, your financial situation, and the potential risks is crucial. By asking these three key questions, you’ll be better equipped to make an informed decision that aligns with your homeownership goals.
Leave a Reply