With an ARM, the interest rate on home loans is adjustable and can go up or down depending on market conditions. An ARM generally offers lower rates than comparable fixed-rate mortgages and may be a good choice for those who don’t plan to stay in their home for long.
Despite the potential savings, there are some key things that borrowers need to keep in mind. One of the primary benefits of an adjustable-rate mortgage is its lower initial interest rate. This rate is often lower than comparable fixed-rates and can save borrowers a significant amount of money as they pay off their loan. However, this low initial rate comes with a catch — after a predetermined period of time (typically five, seven, or ten years), the interest rate will reset to the current market rate. This could be higher than what was initially offered, leading to a noticeable hike in the borrower’s monthly payments.
One way to guard against this kind of sudden increase is to look into hybrid ARMs. These are mortgages that offer an initial fixed rate for a predetermined period of time (generally three, five or seven years) before shifting into an adjustable-rate mortgage. This gives borrowers the benefit of a fixed-rate while also allowing them to pay a lower interest rate than a comparable fixed-rate mortgage.
Another factor to consider when deciding whether an ARM is the right mortgage for you is the stress test applicable in your jurisdiction. Stress tests are designed to assess whether borrowers have sufficient income to afford a loan at a potentially higher rate in the future. While the details of the stress test vary from region to region, in general it requires that the borrower must be able to prove they have enough income to cover the mortgage payments even if the interest rate rises to a certain percentage.
Adjustable-rate mortgages may be an attractive option for borrowers looking to save money in the short-term, but it is important to remember the potential risks. Borrowers should be aware of the potential that their monthly payments could rise significantly in the future and be prepared to cover the costs. They also need to make sure that they can pass the applicable stress test so that they are in a position to make their payments if the rate goes up. With these considerations in mind, ARMs may be a good choice for those who know they won't stay in their home for the long-term.
Adjustable-rate mortgages (ARMs) have become increasingly popular amongst homeowners due to their lower initial interest rate compared to comparable fixed-rate mortgages. ARMs feature an adjustable interest rate that can go up or down based on market conditions. Initially, this rate is much lower than the fixed-rate mortgage, making it a great choice for those who don't plan on living in their home long-term.
For all its potential savings, however, there are a few key things that borrowers should take into consideration before opting for an ARM. As the initial rate is only available for a predetermined period of time (usually five, seven or ten years), it will eventually reset to the current market rate. This rate could be much higher than before, resulting in a noticeable increase in monthly payments. To avoid this potential price shock, borrowers could instead opt for one of the hybrid ARMs, which offer an initial fixed rate for three, five or seven years before switching to an adjustable rate. Additionally, borrowers should assess whether they will be able to pass the stress test required in their region; this test assesses whether the borrower has enough income to support a mortgage at a higher rate.
In summary, adjustable-rate mortgages can offer a great financial advantage, especially for those looking to save money in the short-term. Careful planning and consideration is required to ensure that the borrower is ready to meet any increases in monthly payments should the interest rate rise in the future. If borrowers take the time to properly examine the pros and cons of ARMs, they could find that these mortgages are the perfect fit for their long-term plans.
This article was contributed on Oct 29, 2023