Every mortgage loan is a little different. For some borrowers, it’s feasible to put 20 percent down at the outset of the life of the mortgage; for others, putting more or less down is a better it. Some home buyers opt for 15-year loans, and some, 30-year loans. And while many borrowers opt for a fixed-rate mortgage, for which the interest rate does not waiver during the life of the loan, sometimes an adjustable-rate mortgage, commonly known as an ARM, makes more sense.

What is an adjustable-rate mortgage?

An ARM is a home loan that carries a set interest rate for a certain period of time. The popular ones include 3,5,7 and 10 year fixed time periods. After this time, the interest rate can change, often yearly, to reflect current interest rates. An ARM typically has an attractive lower interest rate to begin with, but since no one can know what changes will occur in the market, it’s a bit of a guessing game as to how much the rate might change after the initial interest rate period expires. In a favorable rate market, the interest rate might actually drop, but given that recent rates have been among the lowest in history, it’s more likely that your mortgage interest rate will rise following the initial period of the loan.

Many ARMs carry an Interest rate cap to ensure that payments will not get out of hand even if interest rates soar. These caps are both on an annual basis and for the life of the loan. Many ARM’s allow for a 2% increase yearly after the fixed period of time and a maximum of 5% over the life of the loan. Be aware that different ARM’s carry different caps. 

What factors contribute to the decision to secure an adjustable-rate mortgage?

There are several considerations when deciding to pursue an ARM with your lender. How long do you intend to live in the home? Is refinancing an option you would consider? Or might you be able to pay off the loan quickly to avoid seeing a rate increase? Your personal budget is a main consideration as well. Do you have enough financial wherewithal to handle a significant increase in your monthly payments once the initial interest term expires? 

Market trends are also a factor to consider. If interest rates are expected to trend downward, an ARM is a more attractive option than if they are predicted to rise. Downward trends are usually short-lived, so this can be a risky judgment to make. While signing up for an ARM can save money for short-term homeowners, those who wish to stay in a property for a long time without the uncertainty of refinancing may wish to consider the stability of a fixed-rate loan.

What are the pros and cons of an adjustable-rate mortgage?

In order to make the decision about whether an ARM is right for you, it’s important to weigh the benefits and drawbacks of this type of loan. Most important is your level of comfort with meeting likely increases in your monthly mortgage payments. For short-term homeowners or those who wish to “flip” a property, the low initial interest rate of an ARM can be an attractive option because the home will be up for sale before a higher interest rate kicks in. For those planning to stay in a home long term, an ARM can be a bigger risk, resulting in increasing debt if interest rates rise.

If you do have an ARM and the payments are getting difficult to make, refinancing can be an option, but only if your home has retained its value. If the market has slumped and you owe more than your home is worth, refinancing a property that is “under water” might not be feasible. Borrowers taking on an ARM need to take this possibility into account as well.

As always, if you are weighing your options for a mortgage loan, it’s a good idea to speak with a loan officer about different financing choices. He or she will be your best resource in determining the mortgage that best fits your needs.