Understanding Adjustable-Rate Mortgages (ARMs): A Level-Headed Guide for Homebuyers
If you’re a homebuyer willing to embrace some uncertainty for the chance to secure a lower interest rate, an adjustable-rate mortgage (ARM) may be the right option for you. These loans can be particularly advantageous for buyers intending to rent or flip a property, or those who plan to relocate before the fixed-rate period concludes.
In this article, we’ll delve into how ARMs work, explore scenarios where they may be preferable to the more popular fixed-rate mortgages, and present current ARM rates from leading lenders.
ARM Mortgage Rates at Top Lenders
According to recent data available as of [DATE], here are sample ARM rates provided by various financial institutions. Please note that these rates are based on specific assumptions about the borrower’s credit and location, and your actual rate may differ.
| Lender | ARM Type | Interest Rate | APR |
|---|---|---|---|
| Bank of America | 7/6 ARM | 5.500% | 6.460% |
| U.S. Bank | 7/6 ARM | 5.750% | 6.524% |
| Zillow Home Loans | 7/6 ARM | 6.000% | 6.673% |
What is a 7/6 ARM?
A 7/6 ARM offers a fixed interest rate for the first seven years, with adjustment periods occurring every six months thereafter.
Fixed-rate Mortgages vs. Adjustable-rate Mortgages
Fixed-rate mortgages constitute about 92% of all mortgages in the U.S. Unlike ARMs, where interest rates may fluctuate post the initial fixed period, fixed-rate mortgages provide stability by locking in the same rate throughout the term. This predictability can be appealing to many borrowers.
Nevertheless, ARMs can be attractive in specific situations. Approximately 8% of borrowers opt for ARMs, often because of unique advantages they offer.
When to Consider an Adjustable-rate Mortgage
1. Starter Home Buyers
If you plan to move within a few years, an ARM may enable you to benefit from a low initial rate, avoiding concerns about future rate adjustments since you’ll likely sell before the fixed period concludes.
2. Real Estate Investors
For investors looking to flip or rent properties, ARMs can help minimize initial costs. They can reassess rental rates or sell the property as interest rates evolve.
3. Borrowers in High-interest Markets
In times of elevated interest rates, ARMs may provide more affordable upfront costs, with the potential for reduced payments if market conditions improve.
How Adjustable-Rate Mortgages Work
ARMs typically feature a low fixed interest rate for a predetermined duration—ranging from three to ten years—followed by periods of adjustment. Key factors influencing ARM rates include:
- Benchmark Indices: ARM rates are often tied to indices like the Secured Overnight Financing Rate (SOFR), which reflect overnight borrowing costs for banks.
- Margins: Lenders add a fixed margin (typically between 2% and 3.5%) to the benchmark rate for the final ARM rate.
- Caps: Rate caps limit how much the interest rate can increase during specific intervals or throughout the loan term.
Common ARM structures include 5/1, 10/6, and 7/1 types, with fixed rates for initial periods followed by varying adjustment schedules.
Refinancing from an ARM to a Fixed-rate Mortgage
If your circumstances change—say, you decide to stay in your home longer than anticipated—you can refinance to a fixed-rate mortgage. This process is akin to refinancing from one fixed-rate loan to another, requiring you to shop around for rates, provide necessary documentation, and pay off your current mortgage.
Pros and Cons of Adjustable-rate Mortgages
Like any financial product, ARMs come with advantages and disadvantages to weigh before applying. Consulting with a reputable loan officer can help you determine if this mortgage type suits your needs.
Pros
- Lower Initial Rate: ARMs often start with lower interest rates compared to fixed-rate loans.
- Easier Qualification: Some borrowers may find it easier to qualify for an ARM than for a fixed-rate mortgage.
- Potential Future Savings: If market rates decrease, your monthly payments could also decrease during adjustment periods.
Cons
- Possibility of Rising Payments: Your rate may increase based on market conditions, leading to higher payments.
- Complex Comparison Shopping: The intricate terms of ARMs can make finding competitive rates more challenging than with conventional fixed-rate mortgages.
- Less Predictability: ARMs often require a tolerance for risk, as they lack the stability of fixed-rate loans.
Conclusion
Adjustable-rate mortgages can be an excellent option for certain homebuyers, especially those who anticipate moving or investing in properties. Whether it’s the prospect of lower rates during the initial period or specific financial strategies, understanding how ARMs work will empower you in your homebuying journey. Remember to consider your financial goals and consult a trusted loan officer to determine the best mortgage type for your circumstances.
