- Rising mortgage rates are making homes less affordable for buyers.
- You could lock in some initial savings with an adjustable-rate mortgage, but that only makes sense in some situations.
It might seem like a good idea, but there are risks involved.
If you've been looking to purchase a home, you're no doubt aware that mortgage rates are the highest they've been in years. And at a time when home prices are also sky-high, that makes for a tough financial situation.
As such, you may be considering an adjustable-rate mortgage (ARM). Unlike fixed-rate mortgages, which give you the same interest rate throughout the life of your loan, the rate on an ARM will only stay in place for a few years before adjusting year to year after that.
Now the upside of getting an ARM is being able to lock in a lower initial borrowing rate than what you'll see with a fixed loan. Case in point: As of this writing, the average 30-year loan rate is 5.7%. By comparison, the average 5/1 ARM rate is 4.549%. That's a big difference, and that ARM could result in much lower monthly payments -- at least for the next five years.
However, it's what happens after those five years are up that should worry you. As mentioned, the rate on an ARM can fluctuate over time. And so you might start out with a rate that's competitive only to see that rate rise year after year as you're paying off your home.
As such, signing an ARM is a risky move right now, despite the potential savings. There may, however, be one exception that makes an ARM worth it.
When you know you're not staying put
If you're buying your forever home, then getting an ARM is a risky move today, even with the potential savings involved. But if you're purchasing a starter home you know you plan to sell within a few years, then an ARM may not be such a poor choice. In that situation, you might, conceivably, be out of that home before your loan's interest rate begins to rise.
That said, you might purchase what you think is your starter home only to decide to stay there a lot longer. And in that case, you run the risk of your home loan's interest rate rising on you.
Don't count on refinancing, either
Some buyers move forward with an ARM even if they're buying a forever home. The logic is that they can simply refinance to a mortgage with a lower interest rate once their ARM starts to climb.
But that makes the assumption that refinancing will make financial sense. We know what mortgage rates look like right now. We can't predict how high or low they'll be down the line.
And so say you sign an ARM at 4.5% and then try to refinance it in five years. If, at that point, the cheapest fixed-rate loan you can get is a mortgage at 8.5%, you're apt to wind up unhappy.
That's why you can't count on being able to refinance an ARM. To an extent, you also can't count on moving out of your starter home before your ARM starts to change, but that's a situation you may have more control over. If you're going to get an ARM, make sure you recognize the risks involved -- and shop around for the best possible rate so you can at least reap more initial savings.
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