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When you secure a mortgage loan, you choose between two primary loan types: fixed-rate or adjustable-rate mortgages.
Each is exactly what it sounds like -- a fixed-rate mortgage has an interest rate that never changes during the repayment process, while an adjustable-rate mortgage (ARM) has a rate that adjusts periodically during the repayment period. When the rate adjusts, this can result in your interest costs and monthly payment changing.
Adjustable-rate mortgages inherently carry more risks than fixed-rate mortgages, but under ordinary circumstances, they make sense for certain borrowers. Right now, however, an adjustable-rate mortgage does not make sense for virtually anyone.
Here are three big reasons why.
1. Rates are at record lows right now
Mortgage rates have repeatedly hit new record lows since March, and it's possible to get a 30-year fixed-rate loan for well under 3.00%, and a 15-year fixed-rate loan for well under 2.5%. These rates are way below what anyone hoped to get just last year, and home loans are now more affordable than they have ever been.
With rates this extremely low, there's not a lot of room to adjust downward. As a result, gambling on an adjustable-rate mortgage is a bad bet -- there's almost nowhere for rates to go but up.
2. The average interest rate on ARMs is higher than on fixed-rate loans
Speaking of record-low average mortgage rates, that primarily applies to fixed-rate loans -- not ARMS. In fact, the average interest rate on a 30-year fixed-rate loan has consistently been below the average rate on adjustable loan alternatives.
This is pretty unusual, based on the historical track record of mortgage loans. ARMs usually have lower starting rates than fixed-rate loans do. In fact, the initial low introductory rate is usually what convinces borrowers to gamble on these loans despite the uncertainty that comes with the potential for rising rates.
Borrowers may be willing to chance rates going up in the future when they get a lower rate and more affordable monthly payments at the start of the loan -- especially if they plan to refinance, or don't think they will stay in their house for a long time.
There's no reason to take a chance on rates rising if you don't get an initial period with an interest rate below the fixed-rate alternative.
3. Economic uncertainty makes predicting future affordability difficult
When you apply for an adjustable-rate mortgage, it's important to make sure you can afford the payments if they adjust up to the maximum potential limit. Otherwise you take too great a risk of losing your home to foreclosure.
Unfortunately, COVID-19 has left most people's economic futures uncertain. It's not clear exactly when the virus will be fully under control, when the threat of lockdowns will disappear, and when the country will recover from the recession the virus has caused. That makes it a bigger gamble than normal to opt for an ARM and risk rates going above what you can comfortably pay.
You don't want to take that chance, especially when you get no benefits from an ARM with a starting rate higher than that of safer fixed-rate alternatives. Instead, just choose whether a 15-, 20-, or 30-year fixed-rate loan is best for you, and opt for one of these more predictable loan options.