What is an adjustable-rate mortgage? An adjustable-rate mortgage is a mortgage option that has variable interest rates as time progresses in the term.
Depending on a person’s financial situation and other variables, they might prefer to go with an adjustable-rate mortgage. For those that have never had to go through the mortgage approval process before, this term might sound a bit confusing. If you do have any confusion at all, Mortgage Assist has a team of dedicated mortgage brokers that go above and beyond to provide you with the best experience. They will go over mortgage rates, the mortgage assist program, and other important factors that will get you started in the right direction.
Many people simply aren’t able to qualify for a mortgage. Mortgage Assist has been able to successfully provide a route for those people in being able to obtain a mortgage. If you’re frustrated about terms like the variable-rate mortgage, a fixed-rate loan, an arm mortgage, or simply want to know the differences between these essential terms, the team at Mortgage assist will gladly help you.
What Is An Adjustable-Rate Mortgage (ARM)?
Variability is the key differential that separates adjustable-rate mortgages from other mortgages. The interest rate doesn’t sit at a fixed point throughout the duration of the mortgage agreement. If you take a look at the starting interest rate on an ARM, you’ll notice that it’s a lower market rate as compared to other loans. As time progresses, the interest rate will fluctuate. If a home-buyer has the ARM for a long period of time, the interest rate will begin to get higher than, for instance, a fixed-rate option.
ARMs start with an interest rate that will remain the same for a certain duration of time. After that time period passes, the interest rate will start to change. If there’s an adjustment period that is briefer, then the interest rates typically reflect that and will be lower. Once the initial term expires, the loan will restart all over again. This means that there will be a brand new interest rate that reflects the market rates of today. This rate will be the new rate until things reset again, and that could potentially be within a year.
Adjustable-Rate Mortgage Terms
ARMs are known to be more complicated than other mortgage options. It’s good to dive into what some of the terms even mean behind it all so that borrowers will have a better understanding of which one to select when the time comes for them to do so.
Adjustment Frequency: This is the duration of time that goes by for interest rates.
Adjustment Indexes: All of the interest rates are typically attached to a backbone to go off of. That backbone can sometimes be a certain type of asset, whether it be certificates of treasury bills deposits, but it can also be based on the Cost of Funds Index and the London Interbank Offered Rate (LIBOR).
Margin: The margin is what you sign off on that states that you’ll comply with the rate of payment that’s more than the adjustment index. An example of this can be when the adjustable rate is a rate of one year plus 2%. The additional 2% is known as the margin.
Caps: Caps are the limit to how much the interest rate can go up to in any given adjustment period. Sometimes you’ll see ARMs having caps on each monthly payment. The caps are what will keep payments lower on negative amortization loans, but the payments could potentially only be able to account for a certain percentage of the interest that’s due. If you have interest that isn’t paid, that will start to become included with the principal. This amount can add up after a while, and that can result in the principal being a higher amount than what you even borrowed in the first place.
Ceiling: The adjustable interest rate can only go up to a certain point throughout the duration of the loan, and that is known as the ceiling.
One of the best things about an ARM is that it is known to be a lot cheaper than other mortgage options for the first stint of the mortgage schedule. This can result in cheaper payments for up to seven years in comparison to what you might be paying with fixed-rate mortgages for instance. These smaller payments, at least in the beginning, are what attract people to them. This gives the mortgage broker the ability to qualify the borrower for a higher amount at a lower interest rate and lower payments. The borrower also won’t have to worry about refinancing their mortgage at any point in the near future.
Those seeking a mortgage that chooses to go with an ARM will potentially be able to save hundreds of dollars a month for at least the first seven years of the mortgage. At that point, the costs will probably go up. Current market rates will determine the new rate that borrowers will be paying. Some people tend to get lucky in this category and find out that their new rate might even be lower because of the conditions of the market.
There are some negative aspects to the ARM, though. For people that like to see the same monthly payment every single month, they might not find that with the ARM. Monthly payments can change quite often throughout the loan period. For those that decide to take out a huge loan at the beginning, they might be in for a surprise once the interest rates start to go up. Some of the ARMs out there are compiled in a way that the interest rates could potentially even double within the span of just a couple of years.
A lot of financial planners opted against ARM during the mortgage crisis of 2008 that resulted in tons of short sales and foreclosures of homes. Many borrowers also dealt with a lot of shocks as well when they started to notice that their payments were going through the roof. Since that period, there have been government regulations set in place to avoid a massive financial crisis like that one from occurring in the future. Borrowers are now protected from mortgage practices that might be considered to seem a little predatory. In addition, lenders are also now a lot more careful and are screening borrowers more thoroughly.
What Factors Should I Consider With Adjustable-Rate Mortgages?
There is a wide range of factors to consider when you’re doing your research on mortgages. One of the biggest things is figuring out if your financial situation will be able to cope with the changes in the market. Not everyone’s finances will remain the same from month to month or year to year. Interest rates go up and down all of the time, the economy is never sitting on a completely straight line, and you need to ask yourself a number of questions before signing a mortgage agreement.
- How big of a mortgage payment are you comfortable with?
- Can you afford the mortgage payment currently?
- Do you know how long you think you’ll be living in the home?
- Taking a look at interest rates, are you financially prepared if they rise for the foreseeable future?
For those that might be considering an ARM, you’ll want to consider the worst things that can happen. This is always a good way to see if you’ll be prepared in the future for negative circumstances such as interest rates doubling. After looking at the worst-case scenario, compare the amount you think you’ll be saving with the ARM in comparison to other mortgage options. After that, your answer will become more clear on what choice to go with.
If interest rates are currently high and the market indicates that they’ll soon start to go down, an ARM will be able to assist you in taking full advantage of that once they do go lower. If the current interest rates in the market are looking like they’re rising steadily and you’re the type that likes stability in your payment cycles, then you might want to go with another option instead. a fixed-rate mortgage instead.
ARM Prime Candidates
People Who Are There For The Short-Term
An ARM is wise for those that want smaller initial payments. If that’s the only criteria you currently have, then consider an ARM. An ARM is also ideal for those that don’t have any long-term plans on staying in the home. Because the fixed-rate duration of an ARM fluctuates up to about seven years, those that are considering staying in the home for longer than that might not be too attracted to that option after the seven-year point starts rolling around. If you 100% know that you’re going to be leaving the home in a couple of years, then going with the ARM is a very understandable decision to go with.
Consider the interest rate of 3.5% on an ARM that is five years in duration. If you went with a fixed-rate mortgage of 30-years, the interest rate would be 4.25%. Suppose your plans are to leave before the five-year mark when the ARM will reset. A lot of money will be saved in interest with the ARM route. But, if you end up deciding to stay in the home much longer than you originally anticipated, then the total of the mortgage will end up costing a lot more in the long-run. Many people purchase their initial home with no plans to stay in it for more than a few years. Some people purchase the home, start a family, and then upgrade within three years. If this is what you foresee in your future, then an ARM will work great in those circumstances.
Income Boosters
If you’re one to have the same income levels from year to year, fixed-rate mortgages are a wise choice. If your income tends to increase every year due to promotions or owning a business that starts to grow, then an ARM makes sense and could work to your benefit in the long-term.
If you’ve been working in a position where your boss is retiring within the next two years and you’re next in the line of seniority for their position, you’ll typically be expecting a pay increase. This pay increase will be able to help you pay off the mortgage once the interest rate period increases. This is another example of where an ARM will work. Some people also have unexpected trust payments throughout their lives that will help them make the payments of the new and increased interest rate. Any situation where your income is gradually increasing will help you realize if an ARM is right for you.
Pay Things Off Quick Types Of People
For those who like to pay off things really fast, ARMs are perfect. Some people know they will have the money to pay off the entire loan before any interest rate resets begin. Most people aren’t in this type of financial situation to do so, but there are a few that can do it.
If you look at an example of someone that is purchasing a new house while selling their old one at nearly the same time, they might be compelled to buy the new house even though the old house will be under contract. They might want to take out a two or three-year ARM in that case. After the borrower sells their house and is paid, then they can just pay off the rest of the ARM from what they just made from the sale.
For those that are able to make payments on a home before the interest rate reset takes place, an ARM is a very wise decision to go with. Even though an ARM is known to be a little riskier, it can still have a lot of benefits that will go a long way in certain financial situations.
Borrowers need to be careful of what option they decide to go with. Doing your research and considering your entire financial past, present, and future will help you make the decision. One thing to keep a note of is that you shouldn’t only go with an ARM because the initial monthly payments are lower. Some people do this in order to purchase their dream homes and it ends up being a huge gamble.
Which is better, a fixed or adjustable-rate mortgage? As you can see, this question requires careful scrutiny into your finances and future living situation. For people that like to live on the edge a little bit more with their finances and are a little bit riskier, ARMs are perfect. But many people don’t like to deal with the added stress of not knowing where their financial situation will be in seven years from now. A lot of people just like seeing the same monthly payment for the foreseeable future. Like most things, each option has its own set of benefits and its own set of downsides. Sometimes the initial monthly payment with ARMs will tempt people into making a decision that they later regret. And in some cases, that decision could come and haunt you in a couple of years down the road when the interest rates rise and you’re no longer able to afford the mortgage.
Knowing what your job situation or financial situation will be like in seven years down the road isn’t the only thing to consider either when you’re considering going with an ARM. You also need to consider things like your current health situation and if kids will become part of the future picture. What if you decide to go with an ARM and end up getting a disease that interrupts your ability to work in the next few years? When it comes to long-term health, not many people give it much thought and might think that everything will just be fine, and unfortunately, this isn’t always the case.
