When Is an ARM (Adjustable-Rate Mortgage) a Good Choice for Homebuyers?

When Is an ARM (Adjustable-Rate Mortgage) a Good Choice for Homebuyers?

As you set out to buy a home, you’re faced with many choices. One of the most important decisions is the type of mortgage you’ll take out to finance your purchase.

Mortgages come in several varieties, all designed to meet different buyer needs. A fixed-rate conventional mortgage, for example, remains the most popular choice among homebuyers, but there are a number of options to consider, including FHA , Jumbo and even an adjustable-rate mortgage (ARM).

An ARM makes a lot of sense for certain buyers, but whether it’s right for your situation, depends on several factors including your long-term plans and goals.

What Is an Adjustable-Rate Mortgage (ARM)?

An adjustable-rate mortgage is exactly what the name implies—a loan with an interest rate that changes over time. This leads some buyers to believe the interest rate is constantly changing or will dramatically rise after a short period. That is not the case.

Actually, the introductory rate associated with your ARM will remain in effect for a fixed term determined at the time you take out your loan. That could vary depending upon the financial institution, but it is common to see 7-, 10- or 15-years.

After the initial period ends, the interest calculated on your loan may change, depending upon mortgage rates at the time. For instance, if borrowing rates have risen since you took out your original ARM, you can expect the interest on your loan to do the same. However, if mortgage rates have fallen, you’ll see a reduction in the interest associated with your loan.

Advantages of an Adjustable-Rate Mortgage

An ARM offers several advantages to potential home buyers. For one thing, it locks you in at a lower interest rate during the introductory period than a conventional loan.

It doesn’t take much fiddling with a calculator to realize that a lower interest rate equals a smaller monthly payment. By paying less each month on your mortgage, you may be able to afford a larger home or simply find breathing room in your budget during the introductory term.

Speaking of introductory terms, because you can lock in that lower interest rate for a set period, an ARM can be a viable choice for buyers who plan to sell in the near future. For example, if you think you will move to a new location or upsize to a bigger home within five or six years, an ARM with a 7-year introductory rate will have you paying less up-front interest.

At the same time, you’ll enjoy a lower monthly payment. In this sense, an ARM could help you get into the home of your dreams faster, by allowing you to build equity in a larger starter home than you may have been able to afford with a conventional loan.

Another thing to keep in mind is that interest rates don’t always rise after the introductory term with an ARM. It’s possible that the new lending rate might be lower than when you took out your loan. That means your ARM will adjust downward, resulting in less interest and driving down your monthly payment.

Things to Consider with an Adjustable-Rate Mortgage

As with any loan, it’s important to be aware of all the conditions associated with an ARM. You’ll naturally want to pay attention to the length of the introductory terms being offered and select one that aligns with your plans and goals.

Also, keep in mind that if interest rates do rise at the end of your initial term, you can refinance to a conventional loan or even another ARM. Adjustable-rate mortgages are available for refinancing as well as for buying a home.

Most importantly, before deciding on an ARM loan, know your financial goals and whether this is the best path to meet them. This is where a loan officer is such a valuable asset on your home buying journey. They can discuss your options, as well as your financial and homeownership plans, to put you in the right lending product for your situation.

An adjustable-rate mortgage just might be the way you get into the home you want now, while still considering your future financial goals and aspirations.