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You heard about them, but what are they? Now that you are in the market to buy a home, we will take you through the benefits and the drawbacks of the Adjustable Rate Mortgage. Is it right for your family?
Benefits and Drawbacks of Adjustable Rate Mortgages
Many people are conservative by nature. To these people an adjustable rate mortgage can be a scary proposition. But an ARM is not necessarily a bad thing. In fact, an ARM can have many advantages over the conventional fixed-rate mortgage. Let’s look at some of the drawbacks and benefits.
Drawbacks of an adjustable rate mortgage
The most glaring drawback to an ARM is uncertainty. The uncertainty comes from the fact that the interest rate fluctuates with the market. This means that unlike a fixed-rate mortgage, which has a locked-in rate, your monthly mortgage payment will fluctuate too.
This can be a big disadvantage to people who like the certainty of knowing what their payment will be every month. Here are some of the other drawbacks:
- First and foremost, ARMs are difficult to understand because they use terminology associated with them that that is much harder to understand than a fixed-rate mortgage.
-The rates could rise significantly over the life of the loan
-The initial interest rate is always much lower than the market rate. But the rate could adjust higher than the current available fixed-rate mortgages.
Even though ARMs have caps (the maximum percentage points a rate may rise), they don’t always apply to the first charge (due to the fact that the initial rate is artificially low.) So, your first adjustment can be much more than you were expecting.
-On certain ARMs, called negative amortization loans, borrowers could end up owing more money than they actually borrowed. That’s because, the payments on these loans are set so low (to make the loans even more affordable) they only cover part of the interest due. Any additional interest due gets rolled into the principal balance.
Benefits to an adjustable rate mortgage
Despite these drawbacks, there are many benefits to ARMs. They are especially advantageous to those who don’t plan to stay in a home for a long period of time. The initial period of low interest rates might be long enough to where they will want to move out of the home before the rates have a chance to adjust. Other advantages to ARMs include:
-Lower initial rates make it possible for people to use that extra savings to buy a home that would initially be priced out of their range.
-Allowing borrowers to take advantage of falling rates without refinancing. An ARM is to your advantage if you believe that rates will go down in the future.
-The initial low payments give borrowers extra money that they can use to save or invest. If you take the difference between what you would pay in 2 years on an ARM versus a fixed-rate mortgage and invest it, that might give you a higher-yield investment.
In conclusion, the two situations listed below offer a great advantage:
-Don’t plan to stay in your home for a long period of time.
-Expect interest rates to go down.
If you don’t like uncertainty, however, you are better off going with a fixed-rate mortgage.