An ARM Can Be Risky… And Rewarding
Summary: How much risk can you handle with your mortgage payment? And are you okay with your payment rising eventually if you can save a significant amount of money early on? Click through to learn if an ARM is right for you.
An adjustable-rate mortgage, usually referred to as an ARM, is a type of mortgage in which your interest rate can rise and fall. Because of this, your monthly payment can do the same.
The benefit of an ARM, though, is that it usually comes with a lower initial interest rate than you’d get with a traditional fixed-rate loan. This can save you a significant amount of money during the early years of your mortgage.
These early years are known as the fixed period of your ARM. During this period, your interest rate doesn’t change. The fixed period usually lasts five to seven years. If your initial interest rate is a lower 5.8%, it will remain that way during your fixed period, whether that period is five or seven years.
After the fixed period ends, though, your ARM will enter its adjustable period. During this period, its interest rate will change, often once a year, according to whatever economic index your mortgage is tied to. Your 5.8% interest rate might jump to 6.9% once your loan enters its adjustable period, which will boost your monthly payment.
And that’s where the risk comes in.
Uncertainty
Because you don’t know what your interest rate will jump or fall to once your loan enters the adjustable period, you must have the financial flexibility to handle what could be a larger monthly mortgage payment.
Yes, you’ll save money during the fixed period of your ARM. But you might spend more during the adjustable period. That’s the uncertainty. You can combat this by making sure that your monthly budget can handle a higher mortgage payment.
Other borrowers plan to sell their homes before their ARM enters its adjustable period, while others plan to refinance to a fixed-rate mortgage to avoid the rising and falling interest rates that come with the later years of an ARM.
Neither of these is a guaranteed solution, though. You might not be able to sell your home if the real estate market is sluggish. Or you might not be able to sell it for enough money to pay off the remaining balance of your mortgage if home values have fallen.
You might not be able to refinance your ARM, either. Most lenders require that you have at least 20% equity in your mortgage before they’ll approve you for a refinance. If your home’s value has fallen, you might not have enough equity to refinance before your ARM enters the adjustable phase.
The only way to deal with the uncertainty of an ARM, then? Be prepared for it by having enough of a cushion in your household budget to handle the higher payments that usually come. Know, too, that ARMs usually come with limits on how much their interest rates can increase during their first jump, how much they can jump from month to month and how much they can increase in total during the life of your loan. These limits can help you better budget for the maximum interest rate your loan can see during the adjustable period.
If you can do this, the savings you receive during the early years of your mortgage might be high enough to justify the uncertainty of not knowing exactly how much you’ll be paying for your mortgage during the adjustable period. Either way, work with financial and mortgage professionals to decide if you can handle an ARM—emotionally and financially.
