How do I know if an adjustable-rate mortgage is right for me?

Homebuyers can choose between adjustable-rate mortgages (ARMs) or fixed-rate mortgages during the loan process.

The best type for you depends on your personal and financial goals, including how long you plan to stay in a home and the monthly payments you can initially afford.

What's in this article?

What is an adjustable-rate mortgage?
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How does an adjustable-rate mortgage work?
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What is the difference between a fixed rate and adjustable rate?
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Adjustable-rate mortgage pros and cons
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What type of mortgage is right for you?
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Talk to a trusted lender at Compass Mortgage
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Let’s dig into how an adjustable-rate mortgage works, the difference between fixed rates and adjustable rates, and the pros and cons to this type of loan to help you decide if it’s right for you.

What is an adjustable-rate mortgage?

An adjustable-rate mortgage has an interest rate that adjusts throughout the life of the loan based on market conditions.

Generally, adjustable-rate loans start with a lower interest rate than a fixed-rate loan, then the rate varies after the introductory period.

The rate will adjust to current market values, so if current rates are lower, you will have a lower rate and lower monthly payment. If they’re higher, your monthly mortgage payments will increase.

ARM rates will continue to adjust periodically, usually at one-year intervals, until you pay your mortgage in full, sell your home, or refinance to a different loan type.

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How does an adjustable-rate mortgage work?

ARM interest-rate adjustments are tied to a certain benchmark, such as the interest rates on a specific index or a type of asset, such as Treasury bills.

When you get an ARM loan, you pay an agreed-upon rate that is a certain percentage, or margin, higher than the adjustment index.

These rates are capped at a certain amount each adjustment period.

Generally, ARMs are a lot cheaper than fixed-rate mortgages for at least the first three to 10 years, depending on which type you get.

Types of ARMs

ARM types are often represented with numbers, such as 5/1. The first number is how long the initial fixed-rate period will last, while the second number is how often the rate will adjust.

The following are some of the most common types of ARMs, with 30-year terms.

Not all lenders will offer every type, so be sure to ask upfront which types of ARMs they offer.

  • 5/1 ARM: Fixed interest rate for first five years, then rate will adjust annually for next 25 years
  • 10/1 ARM: Fixed rate for first 10 years, annual adjustments for next 20 years
  • 5/6 ARM: Fixed rate for first five years, then rate adjusts every 6 months for next 25 years
  • 7/6 ARM: Fixed rate for first seven years, then adjusts every 6 months for remaining 23 years
  • 10/6 ARM: Fixed interest rate for first 10 years, then adjusts every 6 months for the next 20 years

What are ARM caps?

ARM caps put limits on when and how much your interest rate changes.

Your initial cap is how much your rate can change during the first adjustment, while a periodic cap dictates how much it can change on the second adjustment and all adjustments that follow.

There is a lifetime cap that limits the total increase over the life of the loan.

It’s important to understand these caps fully prior to getting your mortgage, so you know how it can affect your payments over time.

What is the difference between a fixed rate and adjustable rate?

Fixed-rate mortgages have a fixed rate for the life of the loan, while ARM rates change over time.

Fixed-rate loans also may offer 15-year, 20-year, or 30-year terms, while ARM loans are usually 30-year.

ARM rates may make a mortgage more affordable for some borrowers at first, since the starting rates are often lower than fixed-rate loans.

It’s up to an individual borrower to determine whether the costs of future adjustments outweigh the initial lower monthly costs.

ARMs often are recommended for borrowers who plan to sell their home within a few years, or refinance to a fixed-rate loan.

However, depending on the market, ARM borrowers may sometimes get even lower monthly payments than initially if rates fall. In that case, they can reap the rewards without ever having to refinance.

Adjustable-rate mortgage pros and cons

Now that you have an overview of how this type of loan works, let’s take a look at the biggest benefits and drawbacks.

Drawbacks

The biggest disadvantage to ARMs is the potential for your monthly payments to increase significantly after the initial fixed-rate period.

The best way to prepare is to fully understand your loan so you can anticipate what may happen, but ARMs are also considered to be a complicated loan type.

The way they’re structured, the fees, and all the influencing factors can be difficult to understand, which can make it harder to know what to expect.

Some ARMs also may have penalties in place if you decide to sell or refinance within the first five years of getting the loan, so be sure you know whether your ARM has this penalty.

Benefits

Drawbacks aside, ARMs can be the right loan for many types of borrowers.

During periods where mortgage rates are rising, it can be helpful for some borrowers to get an ARM and benefit from the initial fixed lower rate.

A borrower can then choose to sell the home or refinance after the fixed-rate period ends, and miss out on any major rate adjustments.

In the event that mortgage rates fall, borrowers will also benefit from lower rates and lower monthly payments.

What type of mortgage is right for you?

To help you decide which type of loan might better suit your situation, consider the following questions:

  • How long are you planning to stay in your home?
  • Are you expecting any major life changes or expenses in the coming years?
  • How quickly are you planning to pay off your mortgage?
  • What direction are current rates heading?

The length of time you plan to stay in your home can help you determine how much you could save with an adjustable rate.

If you’re planning to move within three to 10 years, you could potentially benefit from the lower initial rates of ARMs and move before the rates adjust.

Additionally, if you expect any major life changes, such as starting a business or having children, it may be helpful to have the predictability of a fixed-rate loan.

While it’s difficult to predict where life will be in the next five to 10 years, including where mortgage rates will be headed, it can help the decision-making process in instances where you do have some goals or insight into these factors.

Talk to a trusted lender at Compass Mortgage

If you have questions about whether an adjustable-rate or fixed-rate mortgage is right for you, reach out to the Compass Mortgage team today.

We can help answer your questions and get you started with the preapproval process to determine which type of loan might be best for your unique situation.

At Compass Mortgage, we promise to go above and beyond for you, and to treat you with the highest respect.

These core values set us apart from other loan officers, and allow us to provide an unmatched mortgage experience for our borrowers.

We can’t wait to hear from you!

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