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Is an Adjustable-Rate Mortgage Right for You?
April 26, 2023 by Spectrum Credit Union
Are you in the market for a new home or considering refinancing your current one? Then you’ve likely come across the term “adjustable-rate mortgage” (or ARM for short). While traditional fixed-rate mortgages are more common, ARMs can be a great option for some homeowners — especially when mortgage interest rates are rising.
But ARMs operate a bit differently than fixed-rate mortgages. Here’s what you should know:
How is an adjustable-rate mortgage different from a fixed-rate mortgage?
The main difference between a fixed-rate mortgage and an ARM comes down to interest rates.
Unlike a fixed-rate mortgage, where the interest rate remains the same throughout the life of the loan, the interest rate on an ARM may fluctuate over time depending on market conditions. ARMs typically start with a fixed rate for a specified period, usually between five and 10 years. After the fixed-rate period, your interest rate can increase or decrease at predetermined intervals. Adjustments can happen on an annual, quarterly or even monthly basis depending on your mortgage terms.
How does a variable rate work?
Most ARMs last for 15 to 30 years, including a set number of fixed-rate years. After the fixed-rate period, the remainder of the loan has a variable interest rate.
Different lenders offer different types of ARMs with varying fixed-rate lengths. These are typically described in numbers. For example:
- 5/1 ARM: Has a fixed rate for the first five years of the loan. Then the interest rate adjusts annually for the remaining 25 years.
- 10/1 ARM: Has a fixed rate for the first 10 years. Then the interest rate adjusts annually for the remaining 20 years.
- 5/6 ARM: Has a fixed rate for the first five years. Then the interest rate adjusts every six months for the remaining 25 years.
While the interest rate may go up after your fixed-rate period ends, caps limit just how much your rate can increase.
- Initial cap: This is the maximum amount your interest rate can initially increase after the fixed-rate period ends.
- Periodic cap: Limits how much interest can increase from one adjustment period to the next.
- Lifetime cap: Also known as the ceiling, this puts an overall limit on how much interest rates can increase (or decrease) throughout the life of the loan.
When comparing loan options, be sure to read the fine print. Your lender will include what type of ARM they’re offering, your initial fixed interest rate and the cap limits for the life of your loan.
Why get an ARM?
Choosing which mortgage is right for you depends largely on your budget and your future financial goals, but ARMs do come with benefits:
Lower introductory rates
Many ARMs offer lower introductory rates than the rates you may qualify for with a fixed-rate mortgage. That can mean lower monthly mortgage payments during the fixed-rate portion of your loan.
Payments can decrease
While people often think of an ARM as an increasing monthly mortgage payment, that isn’t always the case. Lenders use different economic indicators — including indexes like theconstant maturity Treasury indexand the Secured Overnight Financing Rate — to determine interest rates. If economic indicators change during your adjustment period, the interest rate on your ARM could decrease.
If you plan to buy a home and settle in for 30 (or more) years, a fixed-rate mortgage with a predictable monthly payment may give you peace of mind. However, if you’re buying your first starter home or you’re not sure where you’ll be in the next few years, an ARM may be a better option. With lower introductory rates, you may save money if you sell your home before the variable-rate period kicks in.
Considering an adjustable-rate mortgage? Spectrum Credit Union offers ARMs with both 15 and 30-year terms and initial fixed-rate periods of up to 10 years. Learn more about our ARM options today. Have questions? Our mortgage loan officers are happy to help you every step of the way. Reach out to us at 510-251-6010.