2 Times to Consider an Adjustable-Rate Mortgage
KEY POINTS
- It's not a great time to be a home buyer, as mortgage interest rates are over 6%.
- An adjustable-rate mortgage (ARM) might come with a lower initial interest rate than you can get with a fixed-rate loan.
- If you're planning to move in a few years, an ARM could make sense for you.
Are you hoping to buy a home soon? It's still not the best time to buy, as the supply of homes for sale remains low, tipping the scales in favor of sellers. Home prices are also up as a result. And, to add insult to injury, mortgage rates are about double what they were in the salad days of late 2020 and 2021, when the average rate for a 30-year fixed-rate mortgage was in the 3% range, per Freddie Mac.
As of this writing, the average rate sits at 6.39%, which will definitely make an already more expensive home even costlier. What's an aspiring buyer to do? Well, you might consider getting an adjustable-rate mortgage, also known as an ARM. Just 1% of surveyed buyers bought a home with one last year, according to the 2022 Home Buyers and Sellers Generational Trends Report by the National Association of Realtors (NAR).
What's an adjustable-rate mortgage?
An ARM is a mortgage loan with an interest rate that changes over the life of the loan, usually once annually after a fixed period of five, seven, or 10 years. The interest rate is determined by a financial index and could either go up or down. What you lose in predictability of what your payment will be for the full term of your loan, you may gain in a lower initial interest rate, which could really come in handy at a time like this. However, ARMs come with a potential drawback.
Since your rate adjusts periodically, you could later end up paying more per month than your initial payment amount. This could put you in real trouble if your income and budget can't support those payments, and you may end up wanting to refinance to a fixed-rate loan before yours begins adjusting. That said, there are a couple times when an ARM might just be a fit when purchasing a home.
1. When you'll get a lower starting interest rate than on a fixed loan
Interest rates for consumer borrowing are up across the board right now. The Federal Reserve's interest rate hikes (10 at last count) since March 2022 were intended to moderate the rampant inflation we've all been living with by making it more expensive for banks to loan each other money. This has the effect of making consumer interest rates higher, too. But if you can save on the first few years (or longer, depending on the type of ARM) of your mortgage, an ARM might be worth considering now. If rates end up falling, your payments might even be lower after that first adjustment.
2. When you're planning to move in a few years
An ARM can be a good way to save money on a home purchase if you don't intend to stay in the house long enough for the interest rate to change at all. Let's say you're planning to move in less than five years, and can get a lower rate on an ARM than on a fixed-rate loan. In this instance, it could make sense to go for the ARM, as you won't be affected by a changing rate if you can stick to your original plan.
Adjustable-rate mortgages have a bit of a negative reputation, but there are some instances where getting one could be a fine choice to buy a home. Just be sure to read the fine print on yours, so you know when to expect rate adjustments. And if you intend to stay in the home for the long haul, you might want to consider refinancing to a fixed-rate loan for more certainty of how much your payments will be over time.
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