Adjustable-rate mortgages (ARMs) are a type of home loan that has been gaining popularity in recent years due to their lower initial interest rates compared to traditional fixed-rate mortgages. However, ARMs come with their own set of risks and rewards that potential borrowers should be aware of before making a decision.
We want to help you understand the pros and cons of adjustable-rate mortgages so that you can make an informed decision about your home loan. In this article, we will discuss the benefits and drawbacks of ARMs, as well as the risks associated with this type of mortgage.
Pros of Adjustable-Rate Mortgages
Lower Initial Interest Rates
One of the primary advantages of ARMs is their lower initial interest rates. This means that your monthly payments will be lower in the first few years of your mortgage compared to a traditional fixed-rate mortgage.
Another benefit of ARMs is their flexibility. Most ARMs offer an initial fixed-rate period, after which the interest rate can adjust annually or semi-annually. This means that you can take advantage of lower interest rates in the future if they become available.
Ideal for Short-Term Homeowners
ARMs can be an ideal option for those who plan to sell their home within a few years. Since the initial interest rate is lower, you can save money on your monthly payments during your ownership of the home. If you sell the property before the interest rate adjusts, you may be able to avoid higher payments altogether.
Cons of Adjustable-Rate Mortgages
One of the primary drawbacks of ARMs is the uncertainty they bring. Since the interest rate can adjust over time, it can be difficult to predict future payments. This uncertainty can be especially challenging for those on a fixed income or who have a tight budget.
Higher Long-Term Costs
While ARMs may offer lower initial interest rates, they can end up being more expensive in the long run. If interest rates rise, your monthly payments can increase significantly, potentially costing you more over the life of the loan than if you had chosen a fixed-rate mortgage.
Refinancing Can Be Difficult
If you choose an ARM and later decide that you want to refinance to a fixed-rate mortgage, it can be challenging to do so. Lenders may be hesitant to approve a refinance if they believe that you may default on your loan due to future interest rate increases.
Risks of Adjustable-Rate Mortgages
Interest Rate Risk
The most significant risk of ARMs is the potential for interest rate increases. If interest rates rise, your monthly payments can increase, potentially making your mortgage payments unaffordable. This risk is more significant for those with lower incomes or who are on a fixed income.
Payment shock is another risk associated with ARMs. This occurs when your monthly payments increase significantly due to an interest rate adjustment. Payment shock can be especially challenging for those on a tight budget or who have recently experienced a change in income.
Negative amortization is a risk associated with some ARMs. This occurs when your monthly payments are not enough to cover the interest owed, and the unpaid interest is added to your loan balance. This can lead to an increase in your total loan balance over time.
In conclusion, adjustable-rate mortgages can be an attractive option for those who are looking for a lower initial interest rate or who plan to sell their home within a few years. However, potential borrowers should also be aware of the risks associated with ARMs, such as interest rate increases and payment shock.