Have you been thinking of buying a new home but are concerned about getting a good mortgage interest rate? Anyone who has been following the news knows that mortgage rates have been trending upwards lately. The historically low rates of the last few years are no longer available today, and, if you are hoping for rates to fall you may be waiting for a while.
Whether you are a first-time home buyer, need to upgrade to a larger home, or need to downsize to a smaller home, you do not need to let market uncertainty stop you from buying that new home now!
That’s because there is a mortgage product available that can enable you to move forward with your dream of homeownership. It’s called an adjustable rate mortgage, and it could be the right choice for you.
According to Bankrate.com, as of July 14th, the current average rate for a 30-year fixed mortgage is 5.73% which, historically speaking, is still relatively low. At the same time, this may make you feel that owning a home is now out of reach. We are here to tell you that, in reality, it doesn’t mean that at all.
In fact, rising fixed mortgage interest rates are precisely the reason that makes an Adjustable Rate Mortgage (ARM) an attractive alternative to a traditional 30-year fixed mortgage. As of July 14th, the average interest rate on an ARM is only 4.27%. This is a difference that will save you hundreds of dollars a month, expand your purchasing power, and could let you buy the home you want sooner rather than later.
Sounds good, doesn’t it? It does if you know what an ARM is and how it works. Unfortunately, most people don’t. In this blog, we will describe what an adjustable rate mortgage is, how it works, and why this is a practical option in today’s market.
What is an Adjustable Rate Mortgage?
An adjustable rate mortgage is a mortgage whose interest rate changes over time-based on the market. ARMs characteristically start with a lower interest rate than fixed-rate mortgages, so it is a terrific option if you need to get the lowest possible rate so you can afford the house you want.
An adjustable rate mortgage contrasts with a fixed-rate mortgage because the rate doesn’t change during the life of the loan with a fixed-rate mortgage. With an ARM, the interest rate changes periodically, usually in based on an index, and payments will go up or down accordingly.
As lenders charge lower initial interest rates for ARMs than for fixed rate mortgages it makes the ARM easier on your wallet than a fixed-rate mortgage would be for the same loan amount. Also, your ARM has the potential to be less expensive over a long period, for example, if interest rates remain steady or move lower over time.
By charging less interest during the initial period, you realize the benefit of a lower initial monthly payment. After the introductory period, fluctuating interest rates will impact your payments. If interest rates go down, ARMs can turn out to be less expensive than fixed-rate mortgages; but an ARM can also become more expensive if rates go up. We’ll address what to do about that a little further down.
But first, let’s take a look at an adjustable rate mortgage works.
How an Adjustable Rate Mortgage Works
ARMs are long-term home loans with two different periods, called the fixed period and the adjustable period.
During the fixed period, your interest rate will not change. Normally the fixed period lasts for the first 5 – 10 years of your loan. After the initial period comes the adjustable period, during which your interest rate can go up or down based on changes in the benchmark interest rate.
For example, let’s say that you take out a 30-year ARM with a 5-year fixed period. That would lead to a fixed rate for the first 5 years of the loan. After that, your rate could go up or down for the remaining 25 years of the loan. That’s not as scary as it sounds because, by law, virtually all ARMs have a lifetime cap which restricts the interest rate rise over the life of the loan.
Why an Adjustable Rate Mortgage is the Right Choice Now
An ARM can be a good option for some homebuyers in the current interest rate atmosphere, even though one cannot foretell the future of interest rate movements. For example, if you are looking for a starter home to live in for a few years before moving up to your forever home, you may not need a mortgage for more than the fixed period, and an ARM would be an attractive option. Also, if you pay close attention to the terms of your loan and plan carefully, an ARM can be a smart alternative to a fixed rate mortgage.
Adjustable rate mortgage advantages are:
- Your initial monthly payments during the introductory time of your loan will be lower than if you had taken out a conventional fixed-rate mortgage. This is an attractive option for someone who is looking to buy a home with rates fluctuating. It could be the difference between affording and not affording a mortgage.
- An ARM can help you save. As you’re paying less at the outset than a traditional 30-year mortgage, you’ll have more available money and can use these savings to add to your retirement or other savings plan, pay down other expenses, or possibly pay down the loan quicker.
- If interest rates drop, your payments will drop. With an ARM, you get the advantage of lower interest rates at the end of your adjustment period. Typically ARM rates adjust annually.
- Even if your payment goes up, it can’t go up too far because ARMs have caps on rate increases. This means that even if your costs go up, there is a boundary. Pay attention to the terms of your mortgage to make sure these maximum increases are numbers you can live with.
- If you’re not planning to stay in the house for long, you could sell the house before your rate increases. By planning prudently, you can appreciate the low initial rates of an ARM while getting out of the mortgage before any rate adjustments kick in.
What to Do With Your ARM if Rates Keep Rising
Earlier I told you that we would talk about what to do if interest rates keep rising. Another development to consider is what to do if interest rates have sharply dropped after the end of your adjustment period below the rate cap.
In either case, you can refinance your ARM into a traditional fixed-rate mortgage to lock in more permanence than an ARM can offer. Fortunately, the procedure is relatively uncomplicated. When you refinance, you’ll take out a new loan and pay off the original mortgage.
When refinancing, many people choose to go with a 15 or 20-year fixed rate mortgage to get a better rate as an alternative to a 30-year fixed rate mortgage. Not only does this save you a lot of cash in interest payments but you also wind up owning your home 10 years faster than the typical home buyer. The other option is to set a 30-year mortgage and make additional principal payments, which will also save you money on interest and shorten the term of the mortgage.
In a time of market uncertainty and rising interest rates, an adjustable rate mortgage can be the right choice for you to achieve your dream of homeownership. It gives you a lower fixed rate for a period of time (most often 5 years) and helps you combat today’s higher fixed mortgage rates.
One stipulation is that you need to pay close attention to what is happening with mortgage interest rates. That way, after your adjustment period ends, you’ll be ready to refinance into a steady fixed rate mortgage if that makes sense at the time.
In a time of rising interest rates an ARM can be the difference between being able to afford a new home or not. In other words, an ARM can mean that your dream of homeownership can still be achieved in a way that won’t be burdensome on your budget.
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And, we have built a referral network of trusted mortgage professionals that we know can take care of your mortgage needs with integrity that we are happy to refer you to. So, let’s connect and get you on the road to owning your dream house today.