Rising interest rates and housing prices may cause you, as a prospective home buyer, to investigate all financing choices. You might not be aware of it, but there is a mortgage option called an ARM (Adjustable Rate Mortgage) that could help you buy the house of your dreams and possibly save you money.
What is an ARM and how does it work?
Alternatives to conventional fixed-rate mortgages include ARMs. Here is a quick explanation of how adjustable rate mortgages (ARMs) function and how to determine whether and when they could be the best home finance option for you.
An ARM begins with a fixed interest rate for a set amount of time, often 5, 7, or 10 years, as opposed to a fixed-rate mortgage, where the interest rate is fixed for the duration of the loan. When that time has passed, the interest rate may alter periodically for the duration of the loan.
A 5/1 ARM, for instance, has a fixed interest rate for the first five years and then a variable rate period when the rate may change annually until the loan is repaid. Accordingly, depending on the loan's terms and the state of the market, the interest rate may increase, decrease, or stay the same.
When does an ARM make sense versus a fixed-rate mortgage?
"The main benefit is that qualified borrowers can likely acquire a lower initial interest rate on an ARM than they could on a fixed rate mortgage. A lower interest rate mortgage loan would result in a lower starting monthly payment.” - Derek Kramer, BANK Mortgage Loan Expert
Another advantage is that this mortgage type might allow for adjustments. After three years of owning a seven-year ARM, you have the option of changing your loan into a different ARM or a fixed-rate mortgage.
When compared to closing on a new loan, modifications often have lesser fees and can be finished in about a week.
This choice could seem riskier than a fixed-rate mortgage due to the possibility of adjustable interest rates. However, the reduced initial payment can make it simpler to move into the house you want right away. You could be able to pay off your principal and increase your equity more quickly with an initial lower interest rate and lower monthly payment.
The sum of money you borrow is your principal. The market worth of a homeowner’s interest in their real estate property is known as home equity. It is computed by subtracting the amount owed on your mortgage or any loans secured by the home from the home's current fair market value.
If you don’t intend to remain in your house beyond the fixed-rate period, this mortgage option might be right for you. For instance, you might not require a 30-year fixed-rate mortgage if you are a member of the military, plan to move, or anticipate outgrowing your starter home after a few years. In some circumstances, an ARM might be a superior financial decision.
Other facts and considerations.
The main thing to bear in mind with an ARM is that, after the initial five, seven, or ten years, the interest rate will probably change, and that this will affect your payments. They may become less expensive than fixed-rate mortgages if interest rates decline, but they may also become comparatively more expensive if rates increase. According to Kramer, who also notes that borrowers be informed at least 90 days in advance of their rate changing, “the new rate is based on two numbers known as the index and the margin, and these should be made explicit in the borrower's loan documentation.”
Market conditions are reflected in the index. The margin is the quantity of percentage points that your lender has added to the index. Your loan agreement specifies the margin, which won’t change after closing.
A lifetime rate cap that establishes restrictions on how much the interest rate can vary overall throughout the life of your loan should also be clearly stated in your loan specifications, as should periodic rate caps that set limits on how much your interest rate can change from one adjustment period to the next. These rate ceilings are in place to safeguard ARM borrowers from a substantial increase in interest rates.
You can use the following additional criteria to determine whether an ARM is the best financing choice for you:
An ARM could be a wise mortgage choice to help you save money with an initially lower rate and payment during times of high interest rates. Before selecting a house loan, it's wise to take into account all available mortgage options, your financial situation, and your goals in any interest rate environment.
In order to better understand your alternatives before choosing between an ARM and a fixed-rate mortgage, Kramer advises borrowers to speak with a mortgage specialist.
Learn more all about the mortgage options BANK offers by contacting one of our Mortgage Loan Experts at 515.223.2265 (West Des Moines), 319.753.2265 or 319.520.5300 in SE Iowa.
Ready to apply or want to learn more? Visit www.BANK.bank/home-loans. At BANK, we make mortgages easy!