Adjustable rate mortgages are still a popular tool in today's marketplace. There certainly is a negative connotation with the ARM. Many homeowners were unable to make the payments on their homes and decided simply to walk away. This was notable during the financial crisis which occurred about a decade ago.
But ARM mortgages are still a financial tool that make good sense.
Let's make one thing clear, the only reason ever to engage in an ARM is for the lower interest rate, which equates into a lower mortgage payment. It's can be primarily for people who don't plan on living in the same home for a longer period of time.
Potential homeowners just need to understand how they operate. We are going to cover some of the more popular ARM options available today.
Remember that with a fixed rate mortgage, your payment will never change. There are no surprises.
As interest rates change in the marketplace, so will the adjustable rate mortgages. Here is some more information that you need to know. ARM's will have a fixed rate period also known as the "teaser rate". During this teaser period, your payment will not change. Once this period terminates, then your mortgage rate is free to adjust according to the type. Here are some of the more popular options with explanation.
3/3 ARM
The first number indicates the length of the teaser period. The "3" means that you will make the same mortgage payment for three years. No matter how high or low interests rates go, you payment will be the exact same for 36 months.
Now after 3 years expires, the rate will adjust. How much it goes up or down will be determined by the market that your rate is tied to. Starting year 4, you will then make the new mortgage payment for years 4, 5, and 6. And again, after year 6, there will be a new rate for years, 7, 8, and 9.
This will continue on until you sell the house or pay it off. Here are the pros and cons. If interest rates spike during year 8, your payment cannot go up. It is fixed for the time being.
The main con is that if rates spike right before one of the resets, you will have to make those higher payments for the next 3 years. Even if rates go down shortly thereafter, your payment won't adjust down until the next reset date.
5/1 ARM
If you desire something a little less risky than the 3/3 then the 5/1 might be worth a look.
Here the teaser rate is fixed for 5 years. Then the rate will adjust yearly until you sell the house or pay it off.
If you are the type of person that doesn't stay in the same place very long, the you could potentially live in your home, sell it, and then move before the teaser period expires.
The 5/1 might be good for someone who believes the home in the neighborhood is undervalued, and will increase significantly.
1/1 ARM
The 1/1 usually gives you one of the lowest rates of all. But they also are some of the riskiest. Here your teaser period is only good for 1 year. Then it resets.
The advantage here is that if rates do go up, then you only have to wait 12 months for potentially lower rates to kick back in so your payment subsides.
Obviously the 1/1 isn't a good option for someone who tends not to move that much or for people on a fixed income. The rate changes here will come quickly and can be quite significant. Potential homebuyers might want to consider renting a home rather than engaging in a 1/1 ARM
What We Didn't Cover
ARM mortgages also have rate caps. This limits the amount that rates can go up every time they reset and how high the rate can go over the life of the loan. Ther
This is to prevent shock from the potential surge in a mortgage payment. Check some of the resources below for further examples
For Further Review
If you plan on staying in your house for the rest of your life, then experts will recommend a standard fixed rate mortgage. However, ARM's can be great when you are only going to be in the home for a shorter period of time. You get the benefits of a lower interest rate. However, if you cannot sell the home, you might be in trouble.
Resources:
https://www.rentkidz.com/why-an-arm-mortgage-deserves-your-attention/
https://www.lendingtree.com/home/mortgage/rate-caps-can-curtail-arm-payment-shocks/
