2 Reasons to Steer Clear of an ARM Even as Rates Rise

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  • Mortgage interest rates have risen dramatically this year.
  • The average interest rate on a 30-year mortgage is almost 5.5% as of May 5, 2022, while the average rate on a 5/1 ARM is 4.339%.
  • Although this makes ARMs seem attractive, they likely aren't worth the risk.

Don't discount the dangers of an adjustable-rate mortgage.

Mortgage rates have been increasing dramatically this year. As of May 5, 2022, the average interest rate on a 30-year mortgage loan is 5.478%. Since rates were down below 3% just last year, this is a big rate increase and the high rate could make borrowing seem unaffordable.

In light of these high rates, an adjustable-rate loan may seem attractive. The average interest rate on a 5/1 ARM is just 4.339%, which is well below what a typical 30-year mortgage would cost. But while this makes ARMs seem tempting, there are two big reasons why you should likely steer clear of them.

1. ARMs are high-risk loans

The biggest reason why you should avoid adjustable-rate mortgages is the risk that they present.

With a fixed-rate mortgage, your rate and payment cannot change over time once you have secured the mortgage loan. You will know with 100% certainty exactly what your mortgage will cost each month and over the life of the loan if you take out a 30-year fixed-rate mortgage.

This is not the case with a 5/1 ARM. Your initial rate, which is designed to attract you to the loan, is guaranteed only for five years. That's a very small percentage of the time that you will be paying on your 30-year mortgage. After the five-year period is over, your rate will move with a financial index.

If your rate moves up, your monthly payment could climb and could potentially become unaffordable. Total borrowing costs could also increase, which would mean more of your money would have to go to your lender rather than to other financial goals.

Taking a chance that your payments could become hard to afford in the future likely isn't worth it. You're better off opting for a loan that has a steady payment you're sure you can afford -- even if that means you must pay a higher rate now. That can be a small price to pay for the certainty of ensuring your mortgage is within your budget.

2. Rates could rise further

Although mortgage rates are currently much higher than they were during the heart of the pandemic, they are still relatively affordable based on historical data. In fact, rates were above 6% as recently as 2008.

There is a good chance rates will continue to rise over the coming years. That's especially true because inflation has surged to record highs and the Federal Reserve has been moving to raise interest rates to help combat rising prices.

Since it's entirely possible rates will move higher when your mortgage begins adjusting, you may not want to take the chance of an ARM. If rates go up, you could find your loan becomes much more expensive as mentioned above. And it may not be possible to refinance into an affordable loan at that time since the rates on refinance loans may be much higher than the rates you'd pay for a 30-year loan today.

If you don't want to take the chance your mortgage will cost you much more in the future, you should opt for a 30-year fixed-rate loan today. You can always refinance it if rates fall, but at least you will have the certainty of knowing exactly what your loan will cost you over time if you can't or don't want to secure a new home loan later.

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