If you’re in the market for a mortgage, you may be considering an adjustable-rate mortgage (ARM). Unlike a fixed-rate mortgage, an ARM has an interest rate that can change over time, which can make it more unpredictable and risky. In this article, we’ll walk you through the pros and cons of an adjustable-rate mortgage.
Lower Initial Payments
One of the biggest advantages of an ARM is that it typically has lower initial payments than a fixed-rate mortgage. This can make it easier for you to qualify for a larger loan or afford a more expensive home. If you plan on selling your home before the interest rate adjusts, you can take advantage of the lower payments without worrying about the risk of rising interest rates.
Potential for Lower Interest Rates
Another advantage of an ARM is the potential for lower interest rates in the future. If interest rates drop, your mortgage payment will decrease as well, which can save you money over the life of the loan. However, it’s important to note that interest rates can also increase, which can make your mortgage payment more expensive.
Higher Initial Buying Power
With lower initial payments, an ARM can give you higher buying power. This means you may be able to afford a more expensive home than you would with a fixed-rate mortgage. However, it’s important to keep in mind that your payments could increase in the future, which could affect your ability to afford the home.
Risk of Payment Increases
One of the biggest risks of an ARM is the potential for payment increases in the future. As interest rates rise, your mortgage payment will increase as well. This can make it more difficult to budget for your monthly expenses. In turn, this can make it harder to plan for the future. If you’re someone who likes predictability and stability in your finances, an ARM may not be the option you’re most comfortable with.
Risk of Foreclosure
If your payment increases significantly and you’re unable to make the payment, you may be at risk of foreclosure. This can be a serious consequence of an ARM and is something you should consider before choosing this type of mortgage. It’s important to be realistic about your ability to make the payments in the future, even if they increase.
Potential for Savings
While an ARM does come with some risk, it also has the potential for savings. If interest rates drop, you can take advantage of the lower payments and save money over the life of the loan. However, it’s important to be prepared for the possibility of payment increases as well.
With an ARM, you’ll have less predictability in your monthly mortgage payment. This can make budgeting and future financial planning more difficult for you.
Protection Against Rising Interest Rates
One of the benefits of an ARM is that it typically comes with some protection against rising interest rates. Most ARMs have caps on how much the interest rate on the loan can rise, which can help protect you from sudden and drastic payment increases. However, it’s important to understand the terms of your ARM and the potential for payment increases in the future.
Flexibility
An ARM can offer more flexibility than a fixed-rate mortgage. You may be able to take advantage of lower interest rates in the future, which can save you money over the life of the loan. Additionally, if you plan on selling your home before the interest rate adjusts, you can take advantage of the lower initial payments without worrying about the risk of rising interest rates.
Risk of Negative Amortization
One of the risks of an ARM is the potential for negative amortization. This occurs when your monthly payment isn’t enough to cover the interest on the loan, which causes the unpaid interest to be added to the principal balance. This can make your mortgage payment more expensive in the long run and can make it more difficult to pay off the loan.
Choosing an ARM can be a good option for those who want to take advantage of lower initial payments and the potential for lower interest rates in the future. However, it’s important to consider the risks involved, including the potential for payment increases, difficulty budgeting, risk of foreclosure, risk of negative amortization, and less predictability. Before choosing an ARM, make sure you understand the terms of the loan and the potential for payment increases in the future.
Ultimately, the right mortgage for you will depend on your individual financial situation and long-term goals. It’s important to do your research, compare rates from different lenders, and think carefully about your long-term financial plan before making a decision. With the right mortgage, you can achieve your financial goals and build wealth through real estate.
Resource Links
U.S News & World Report: ARM Borrowers Gamble Short-Term Savings on Long-Term Risk
Consumer Financial Protection Bureau: What Is Negative Amortization?