Does an Adjustable-Rate Mortgage Make Sense in Light of Rising Rates?
- With an adjustable-rate mortgage, your loan's interest rate can rise over time.
- You might reap initial savings with an adjustable-rate mortgage, but you'll need to weigh that benefit against the risks.
It could, but you'll need to be careful.
From mid-2020 through late 2021, mortgage rates were extremely competitive, which made it a perfect time to lock in a fixed-rate mortgage. The upside of a fixed-rate loan is being guaranteed the same mortgage rate throughout your repayment period.
An adjustable-rate mortgage, or ARM, on the other hand, is one whose interest rate could rise or fall over time. Last year, when borrowing was so cheap, it generally made little sense to take out an ARM. But these days, borrowing has gotten expensive, and so it's easier to make the case for an adjustable-rate mortgage. But is that the right move for you?
The upside of an adjustable-rate mortgage
The primary benefit of getting an ARM? Locking in a lower interest rate on your home loan initially.
As of this writing, the average 30-year loan interest rate is 4.912%. For a 5/1 ARM, which guarantees you the same interest rate for five years before that rate starts adjusting once annually, it's 3.92%.
As you can see, you'll shave almost a full percentage point off of your mortgage by signing a 5/1 ARM over a 30-year fixed loan. The result? Much lower monthly payments, at least for the next five years.
The downside of an adjustable-rate mortgage
While you might save money initially with an ARM, you'll bear the risk of your mortgage's interest rate climbing over time. Once that happens, your monthly payments could become more expensive, to the point where they're not even affordable.
Now to be fair, it's possible for your mortgage rate to drop over time when you sign an adjustable-rate mortgage. It will all depend on market conditions. But you shouldn't go in expecting you'll enjoy a lower interest rate over time.
Is an adjustable-rate mortgage right for you?
If you want to enjoy some savings on your monthly mortgage payments, you might consider an ARM. But it's important to recognize the risks involved.
You may also want to steer clear of getting an ARM if you're buying what you're convinced is your forever home. If you're buying a starter home, an ARM may be a more appropriate means of financing it. That's because you might end up selling your starter home before the interest rate on your ARM begins to change.
Another thing to keep in mind is that you can always sign an adjustable-rate mortgage and then refinance it down the line if your rate starts climbing. But while that may be a viable option, it won't necessarily be a cost-effective one.
We don't know what mortgage rates will look like five, seven, or 10 years from now. And it may be the case that interest rates are so high that refinancing won't pay off, leaving you stuck with a mortgage whose rate keeps rising.
All told, adjustable-rate mortgages are definitely a mixed bag. Right now, they could result in a lot of savings due to higher rates for fixed loan products. But you'll need to make sure you know what you're getting into before signing up.
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