Adjustable-Rate Mortgage Demand Reaches a 15-Year High, But Borrowers Should Beware the Pitfalls
- Rising interest rates might make an adjustable-rate mortgage seem appealing.
- While you might reap initial savings with this type of loan, over time, it could cost you more if your interest rate rises over time.
There's a major drawback to not locking in a fixed interest rate on a mortgage.
If you're looking to finance a home, your goal may be to lock in the lowest rate you can on a mortgage. And so you may be inclined to take out an adjustable-rate mortgage (ARM) instead of a fixed-rate loan.
As of this writing, the average 30-year mortgage rate on a national level is 5.668%. Meanwhile, the average 7/1 ARM rate is 4.847%. Clearly, that's a notable difference.
If you're heavily considering an ARM right now, you're not alone. Zillow recently reported that ARM applications are at their highest level in 15 years. But while you might reap some savings initially by signing an ARM, you might come to regret that decision big-time. And so before you rush to take out an ARM, it pays to consider your options carefully.
The downside of getting an ARM
If you take out an adjustable-rate mortgage, you might enjoy a lower interest rate on your loan for a period of time. That could, in turn, make your monthly payments much more affordable.
But there's a big drawback to signing an ARM, and it's that your rate won't stay in place forever. Rather, after a certain period of time (in the case of a 7/1 ARM, seven years), your mortgage's interest rate will be subject to changes based on market conditions.
That doesn't guarantee that your loan's interest rate will go up. In some cases, ARMs do adjust downward. But you'll also need to brace for the possibility of your mortgage's interest rate going up year after year once your initial rate expires. And that could leave you on the hook for much higher monthly payments than you can easily afford.
When you want more peace of mind
Though an ARM might initially save you money on your mortgage, if you're not the type of person who enjoys taking financial risks, then you may want to stick to a fixed-rate loan -- even with borrowing rates being higher across the board right now. If you sign a fixed loan, you're guaranteed the same interest rate until your home is paid off -- assuming that you don't refinance.
And that leads to another important point. If you sign a fixed-rate loan but interest rates start to drop, you can always try refinancing to a new fixed-rate loan at a more favorable rate. And if you have a strong credit score at the time rates start to fall, you might end up reaping a nice amount of savings. But if interest rates start climbing drastically, you'll have the security of your locked-in rate to fall back on.
All told, it's easy to see why an ARM might be appealing at a time when mortgage rates have gotten more expensive. But signing an ARM means taking what could be a really big risk. And so you may want to stick with a fixed-rate loan, even if it means forgoing some savings in the near term to get peace of mind in the long term.
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