As a homebuyer, when it comes time to choose a financing solution for your new home or refinance, it’s not uncommon to be paralyzed by the number of options available. Between everything you need to know about home appraisals, title and insurance, and closing costs, it’s easy to see why so many trust their lender to help guide them through the process.
You will, without a doubt, come across America’s most popular choice for a mortgage as you begin your journey – the 30-year fixed rate mortgage. The stability and predictability of this solution might seem like an easy choice, but your unique financial background and the Fed raising the prime interest rate might actually make an adjustable rate mortgage (ARM) a better choice for you.
So, what exactly is an ARM, and how does it work?
What is an Adjustable Rate Mortgage (ARM)?
An ARM is a mortgage financing solution that offers borrowers a fixed interest rate for a set period of time, and then adjusts the interest rate at regular intervals thereafter depending on market conditions.
Once your initial term is finished, your lender will adjust the interest rate on your loan based on an index. Essentially, they adjust your rate based on the new benchmark interest rate. Depending on market fluctuations, this new rate may actually decrease your monthly payments, though it is possible your monthly payment may rise as well.
For more information about how the index affects your adjustable-rate mortgage, visit the Consumer Financial Protection Bureau.
How does an ARM work?
As we discussed above, an ARM offers a fixed-rate term, followed by regular rate adjustments at designated intervals thereafter. You will often see these terms expressed in fractions, indicating the number of years your rate will be fixed, followed by the adjustment period, or how often the interest rate will change.
To highlight this, let’s use First Heritage Mortgage’s 15/1 ARM as an example. In this scenario, your interest rate will be fixed for 15 years, followed by a rate adjustment each year after. Sounds pretty simple, right?
So why would you opt for the 15/1 ARM as opposed to a 30-year fixed rate mortgage?
The key benefit of the 15/1 ARM, and most adjustable-rate mortgages offered by your lender, is that your rate may typically be lower during the initial term, depending on your credit history and other qualifying factors. This can allow you to build savings, invest in higher-yield opportunities, or even purchase a larger home.
Another major benefit, unique to the 15/1 ARM, is the ability to have stable, predictable payments for half the length of your loan term. This allows you to take advantage of the lower interest rate and evaluate your options for 15 years.
This is an excellent way to maintain the stability of a fixed rate loan while balancing the uncertainty of rising interest rates and market instability.
So, is an ARM for you?
Adjustable rate mortgages are an excellent choice depending on your needs as a homebuyer. We’ve only just scratched the surface on what ARMs are and how they work, and they are much more involved when it comes to the details about indexes, margins, caps on rates and payments, negative amortization, payment options, and recalculating your loan.
Buyers who plan to move in the next few years, or plan to refinance, might benefit the most from this option and the low introductory rates.
Ultimately, you and your lender will decide on the best mortgage solution.
Included content is intended for informational purposes only and should not be relied upon as professional advice. Consult with a mortgage professional to address your questions or concerns. This is an advertisement. Prepared 7/24/2018.