Pros & Cons of an Adjustable-Rate Mortgage
An ARM is a home loan with a low introductory interest rate followed by one that fluctuates. It could be a smart choice for homebuyers who are planning to be in the house for less than a decade.
Adjustable-rate mortgages are not for everyone. Their low introductory rates are appealing, and could help you get a bigger loan, but it’s hard to keep a budget when your payments fluctuate wildly. There are three types of ARMs: Hybrid, Interest-Only and Payment-Option.
Pros
INITIAL PERIOD
Common hybrid ARM terms are 3, 5, 7 and 10 years. With a 5-year ARM, for example, the introductory rate is locked in for 5 years, giving you 60 months of predictable, low payments. If you plan to move or sell the house in the less than 10 years, you could enjoy the fixed-rate period before the less-predictable adjustable phase started.
CAPS & LIMITS
ARMs have caps that limit how much your payment can increase, including caps on how much the rate can change each time it adjusts and the total change over the life of the loan.
FALLING RATES
If interest rates fall and drive down the index against which your ARM is benchmarked, your monthly payment could drop.
Cons
INCREASING RATES
If interest rates rise and drive up the index against which your ARM is benchmarked, your monthly payment will increase—sometimes substantially.
DEFAULT RISK
ARMs require borrowers to plan for when the interest rate starts changing and monthly payments grow. Even so, if something changes and you can’t make the payments after the fixed-rate phase of the loan is over, you could lose the home.
COMPLEXITIES
ARMs can have complicated rules, fees and structures. These complexities can pose risks for borrowers who don’t fully understand what they’re getting into.
