When shopping for a mortgage, homeowners often debate between going with a fixed-rate mortgage or an adjustable-rate mortgage.
In fact, during the housing boom, homeowners often chose adjustable-rate mortgages as a means to qualify for a home they probably wouldn’t be able to afford with a traditional fixed mortgage.
Clearly times have changed, and adjustable-rate mortgages have now fallen out of fashion with fixed-rate mortgage rates hovering near record lows.
In fact, Freddie Mac recently noted that 99 percent of prime borrowers who originally had adjustable-rate mortgages chose fixed rate loans when refinancing.
It’s been an easy choice for homeowners lately, as ARMs aren’t pricing at much of a discount compared to fixed rate loans. But there will come a time when ARMs are back en vogue, so let’s look at some the advantages of these types of mortgages.
Adjustable-Rate Mortgages Have Lower Interest Rates
One of the biggest advantages of an adjustable-rate mortgage is the lower initial interest rate that usually comes with it.
Sure, you don’t have the peace of mind of a fixed rate for the life of the loan, but the tradeoff is a lower rate initially, along with lower mortgage payments.
The savings can be beneficial if you plan to stay in the home for a short period of time, or expect rates to remain steady or fall in the future when it comes time to refinance.
Most ARMs Are Fixed for a Certain Period
Another plus is that most ARMs are also hybrid adjustable-rate mortgages, meaning they’re fixed for some length of time before becoming adjustable.
Examples include 5/1 and 10/1 ARMs, which are fixed for the first five and 10 years, respectively, before adjusting on an annual basis for the remainder of the loan term.
This provides borrowers with the best of both worlds, though it could still land a homeowner in a tough spot if rates rise and they have no intention of selling.
Most Homeowners Only Keep Mortgages for a Short Period
However, most homeowners don’t see their 30-year loans through to the end of term, for reasons like early sale of the property or refinance, so one of these hybrids could be a sensible choice without too much downside risk.
For example, if you are buying your first home, but plan to move or upgrade to a better home as you start a family, an adjustable-rate mortgage might be the best option short-term. And the money saved can be used for a down payment on the next home.
Additionally, the lower interest rate increases affordability, which is not only a plus, but may also be a necessity for borrowers cutting it close in the qualification department (sadly this type of behavior contributed to the current crisis and isn’t recommended).
Never choose an adjustable-rate mortgage just to qualify for a loan. If you can’t qualify for a loan at the fixed mortgage rate, consider holding off or buying a cheaper property.
Should I Get an ARM?
Purchasing real estate is a major investment and one that takes preparation and foresight. You should always plan several years in advance before buying a home, as life changing events can significantly affect your financial situation.
Put simply, you’re taking a risk when choosing an ARM (hence the discount), so take a hard look at the numbers compared to fixed rate options.
While an adjustable-rate mortgage provides financing at a discount, it comes with much more uncertainty, especially in today’s unsteady market. It could be difficult to sell or refinance…
And if you really plan on paying off your mortgage, a fixed mortgage is the best option.
Remember, refinancing your mortgage resets the amortization schedule, and you’ll likely wind up paying more interest over the life of the new loan.
Read more: 30-year fixed vs. ARM
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