Potential homebuyers face many challenges in today’s market. With home prices skyrocketing and interest rates on the rise, many are straying from the popular 30-year fixed rate mortgage for the benefits of an adjustable-rate mortgage, or ARM. For buyers in certain financial circumstances, these loans can be an attractive option.
Adjustable-rate mortgages offer a lower initial interest rate compared to fixed-rate loans. This lower introductory rate eventually unlocks and increases gradually based on an outside index. There are many types of ARMs available to borrowers, including those that adjust annually and others that adjust semi-annually. Most ARMs also include caps on the amount that your monthly payment can increase, keeping the interest rate from suddenly spiking.
According to data from the Mortgage Bankers Association, consumer interest in ARMs is currently at its highest level since 2019. ARMs are also making up an ever-greater number of new mortgages issued across the US. One reason for their spike in popularity is the reality of rising interest rates. Thanks to their lower rates, ARMs also feature lower initial monthly payments compared to their fixed-rate counterparts. This benefit is especially attractive in periods of high interest, when fixed-rate loans can lead to bloated monthly payment amounts.
Interest rates under and ARM will increase over the life of the loan, leading to higher monthly payments in the future. For some buyers, the lower rate in the short term still makes good sense. Borrowers who plan to sell their home after a short time are ideal candidates for an ARM, as are those who are confident their income will increase over time.
Another big advantage offered by an ARM has to do with qualifying for a loan. Because of their low initial payments, ARMs often allow borrowers to qualify for a larger loan compared to their options with a fixed-rate loan. This can give borrowers the opportunity to land a bigger or more desirable home.
ARMs aren’t without their risks. Many of the defaulted loans that contributed to the 2008 housing market crash and recession were ARMs. When home values decrease suddenly, borrowers could face difficulty selling their home. With ever-increasing payments under and ARM, this could be a recipe for default and foreclosure. As with any home loan, it is important to consider the potential risks and rewards before committing to a purchase.
Even if you choose an ARM, your decision is not set in stone. Borrowers who initially select ARMs can eventually refinance and switch to a fixed-rate loan. In theory, a borrower could choose an ARM during a period of high interest, then refinance to a fixed-rate loan when rates decrease. This strategy offers the low initial payments of the ARM with the security of a fixed-rate mortgage. Just keep in mind that closing costs and other fees still apply when refinancing.
Though the popularity of ARMs is on the rise, fixed-rate loans remain the most common loan type issued today. If you’re curious about which type of loan could be right for you or have any other questions about the homebuying process, the mortgage experts at First Ohio are standing by. Contact us today!