Adjustable Rate Mortgages have gotten a bad name over the years, but that doesn’t mean that you shouldn’t consider one for your mortgage or refinance.
Adjustable Rate Mortgages or ARMs got a bad name during the housing market crash. Homebuyers took advantage of the super-low rates and then couldn’t keep up when the ARM adjusted and their monthly payments jumped a few hundred dollars. In the end, it caused many to lose their homes.
While this bad rap is understandable, it’s not totally justified. In part, it can be chalked up to uneducated homeowners who took a risk that they didn’t quite understand.
An ARM is not an inherently bad thing; it’s just a tool that can either be used constructively and with a purpose or haphazardly and perhaps destructively. It can be a great investment tool for people looking either for a primary mortgage or for a refinance.
Here are a few reasons to consider an adjustable rate mortgage:
1.) Low rates: the rates on ARMs are almost always lower than on 30-year fixed rate mortgages. ARMs are best when fixed rates are high and you think that they’ll go down in the future when you can refinance.
2.) You don’t plan to be in your home for that long: If you are only planning on being in your home for a few years, an ARM makes sense. Get a 5/1 ARM (meaning that the fixed rate remains for 5 years) at 3.32% vs. a 30-year fixed rate mortgage at 4.78%, and save a lot of money. Move after 5 years and you’ve come out ahead.
3.) Monthly savings: utilize an ARM and you can save hundreds of dollars per month, even with closing costs. Pay what you would be paying on a higher, fixed-rate loan and pay down your mortgage even faster.
4.) Market rates might go down: It does happen! Market rates might actually go down when it comes time to readjust your loan, which could leave you in an even better position.
5.) You are wealthy: If you are wealthy and have liquid assets that you can stand to lose, then you can probably handle the risk of a rate change.
6.) You are buying a cheap house: Most people need to stretch to purchase a home. However, if you are one of the lucky ones who is purchasing a house that is below your means, then take out an ARM and pay what you would have paid on a fixed-rate anyway and pay down the mortgage faster.
A dose of reality before you pursue an ARM
The ideal ARM homeowner is someone who can anticipate the increased costs after the fixed-rate period or has a solid exit strategy. If you can only afford a house at the lower teaser rate, then an ARM is not the right product for you.
You should always consider what would happen in a worst-case scenario. What if mortgage rates go up to the maximum allowed under the contract? Can you afford that? What if you are not able to refinance or flip your house after the set period is over? Can you afford that?
While an adjustable rate is a good deal it is a gamble that shouldn’t be taken lightly. Only do it if you totally understand the risks and have cleared it with a financial professional who understands your finances. It can be a positive experience if you totally understand the risks involved.
For more information on ARMs, check out the Federal Reserve’s guide to ARMs.
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