- Based on today's mortgage rates, a 5/1 ARM could save you money.
- If you're going to get an adjustable-rate mortgage, it's important to recognize the downside involved.
It may seem like a good option, but there are risks to consider, too.
It's no secret that mortgage rates have risen astronomically since the start of the year. The reason for that is twofold. First, rates were so low from mid-2020 through the end of 2021 that something was apt to give. And also, the Federal Reserve has been moving forward with rate hikes in an effort to quell inflation.
Now the Fed doesn't dictate what rates consumers are charged on a mortgage. In fact, the Fed doesn't set any consumer borrowing rates. Rather, it oversees the federal funds rate, which is what banks charge one another for short-term borrowing. But when the Fed raises rates, consumer interest rates tend to follow suit, so borrowers are now looking at spending more money to take out a mortgage.
If you're looking to get a mortgage, you may be interested in a 5/1 ARM. That way, you'll lock in a lower interest on your loan for at least five years compared to what you'll pay for a fixed-rate loan. But while an adjustable-rate mortgage might seem like a good option right about now, there's a big drawback to consider.
There are pros and cons at play
Right now, the average 30-year mortgage rate is 5.449%. Meanwhile, the average 5/1 ARM rate is 4.547%. At a difference of roughly 1 percentage point, a 5/1 ARM could result in significant savings -- at least initially.
But when you sign a 5/1 ARM, you're only guaranteed your initial interest rate for the first five years. Once that period expires, your loan's interest rate could adjust once a year.
Now here's the tricky thing. When you sign an adjustable-rate mortgage, there's a chance your rate could drop over time rather than rise. But you'll need to be prepared for the opposite to happen, and for your mortgage to get more expensive over time.
Is a 5/1 ARM right for you?
If you're buying a starter home, then a 5/1 ARM could actually be a good choice. There are no rules as to how long you stay in a starter home -- it's up to you. But if you're buying a starter home, there's a good chance you'll upsize after five years, and that makes a 5/1 ARM a safer bet. Once you sell your home, you'll need a new mortgage anyway, so you won't necessarily have to deal with your interest rate rising.
On the other hand, some people buy a starter home that they end up living in for a decade or longer. And so if you sign a 5/1 ARM, you might get stuck with higher interest on your mortgage down the line.
Plus, if you're buying what you believe is your forever home, then signing a fixed-rate loan may be a safer bet. That way, you're guaranteed the same rate and won't have to worry about it moving higher over time.
Another thing to consider is that you can always sign a 5/1 ARM and refinance if it becomes too expensive down the line. Granted, we don't know what refinance rates will look like in five years. But either way, if you opt for a 5/1 ARM, you're not necessarily stuck with it. That's something to think about as you weigh your borrowing options.
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