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What is an ARM | Is the ARM Right For You | Pros &Cons of ARMs | Making the Decision: ARM or Fixed
The current real estate market can be a tricky one to navigate when it comes to finding the right mortgage loan. With 30 year fixed mortgages over 6%, one option you may want to consider is an adjustable rate mortgage (ARM). This type of loan has both advantages and disadvantages, so let’s take a look at what an ARM is, and how it might fit into your financial plans.
What is an ARM?
An adjustable rate mortgage (ARM) is a loan that has a variable interest rate after an initial fixed period that can range from 1-10 years. This means that once the initial fixed period ends, the rate will adjust on a set schedule for the remainder of the loan term (usually 30 years).
In most cases, the payment on the ARM is calculated just like a 30 year fixed loan. The difference is that the ARM rate is fixed for just the first 1, 3, 5, 7 or 10 years. After the fixed period ends, the rate can usually change semi-annually based on the SOFR (Secured Overnight Financing Rate) plus a margin that is set at initial loan approval.
The amount of the adjustment can vary, depending on the loan terms. Most ARM loans have a cap on how much the rate can adjust, typically a maximum of 5% over the initial fixed rate over the 30 year life of the loan.
Usually, the first rate adjustment can go all the way up to the maximum of 5% and then higher or lower by up to 1% with every adjustment thereafter. The rate would never exceed 5% above the initial start rate with these terms.
Is an ARM Right for You?
Whether or not an ARM is right for you depends on a few factors. If you plan on staying in your home for a short period of time, an ARM may be a good choice. The initial rate is often much lower than a fixed-rate mortgage, so you could save thousands of dollars in the short term.
You should consider your future budget. If you believe you may have trouble making payments if your rate increases or if you plan to hold the loan longer than the initial fixed period, an ARM may not be the best choice.
You should also consider your risk tolerance. If you are comfortable taking on the risk of holding the loan once the fixed period ends, an ARM could be a good option for you. In order to mitigate this risk, choose an ARM with a long fixed period, such as the 7 or 10 year ARM. This provides you with a long fixed period to pay down the loan balance, sell the property, or refinance to a lower fixed rate (if available).
Pros and Cons of an ARM
There are both advantages and disadvantages to choosing an ARM. On the plus side, the initial rate is often much lower than a fixed-rate mortgage, currently in the high 4% to low 5% range. This can help you save significant money during the initial fixed period. You can use this option to secure a lower rate for up to 10 years and may be able to refinance to a lower fixed rate option if the mortgage rates decline in the near future.
There are also some drawbacks to consider. The rate can change significantly over the course of the loan, typically up to 5% higher than your initial rate, which can make budgeting difficult. Additionally, the rate can increase beyond the rate of inflation, which could mean that you actually end up paying more in the long run.
Making the Decision: ARM or Fixed-Rate?
When deciding between an ARM and a fixed-rate mortgage, it’s important to consider your financial goals and risk tolerance. If you plan on staying in your home for a short period of time and you’re comfortable with the risk of an ARM, it is a great option to consider.
On the other hand, if you plan on staying in your home for a longer period of time, a fixed-rate mortgage may be a better choice. This way, you can be sure that your rate won’t change over the life of the loan.
In this current interest rate environment, an adjustable rate mortgage (ARM) can be an excellent option to look in to for your home loan. If you are comfortable with the risk of an ARM and understand the terms and conditions of the adjustments, it could be a great way to save money in the first several years of your new loan.
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