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Fixed period armThere is no denying that Adjustable rate mortgages (Fixed Period ARMARMs) are appealing to many homebuyers, but the million-dollar question is: What are the risks In simple terms, an adjustable rate mortgage is one in which the rate changes based on the market interest rates. It is worth mentioning in this regard that the rate will adjust on a specific schedule, say once a year, after an initial fixed period. Always remember that fixed periods range from six months to five years. On the other hand some may have even longer fixed periods. The risk in an ARM comes from having a payment that can change significantly. In case when you have a fixed rate mortgage, you know that your payment will be the same now, ten years and twenty years later. The payment doesn't change due to the simple fact that the interest rate is fixed.
When you choose an adjustable rate mortgage, you accept the risk of a rising payment in return for a lower initial interest rate. Fact remains that this rate is usually much lower than the market rate for a 30-year fixed rate mortgage. The general thumb rule in this regard is the more risk you accept, the lower your initial interest rate. In addition the more adjustments the loan will go through, the more risk attached. According to the traditional point of view even after a loan adjustment, the rates will be lower than those offered to new borrowers for 30-year fixed mortgages. Though, it does happen where this gap closes, especially in periods of rising interest rates.
It is worth mentioning in this regard that the best time to get an ARM is when interest rates are on the decline.
Despite the risk, an ARM can turn out to be advantageous to certain borrowers. While number of advisors will tell you that a fixed-mortgage is the way to go in every situation, there are times when you should consider an adjustable rate.
1. The borrower needs extra cash for some amount of time period:
Always remember that a lower initial fixed rate gives you more money in your pocket early in your loan term. For instance, a one-year ARM with a 30-year term and a rate which adjusts once a year on the anniversary of the loan date comes with zero points and an initial rate of 5.625%. Let's do some comparison that to a 30-year fixed rate mortgage with no points and a fixed rate of 7.625%.
In case if you take out a $240,000 mortgage, the 30-year fixed rate payment would be $1,698.70 each month. On the other hand the one-year ARM would have a monthly payment of $1,381.58. That's an overall difference of $317 a month.
In addition you could use that extra $317 to pay off your credit cards, make improvements to the home or save for retirement. But for that to happen you have to make sure that you will maintain a lifestyle that can afford for your payment to increase. Fact remains that you don't want to find that you cannot afford a higher mortgage payment when the rate adjusts upwards.
2. Buy more home:
Blame it to the lower initial interest rate, you can qualify for a larger mortgage amount and a more expensive home. It is worth pointing that some of the homebuyers secure a one-year ARM with the purpose of refinancing them later. The low rate gives them an option for a more costly home, but a low mortgage payment. But always keep in mind that refinancing comes with closing costs. Thats what does the mathematics to see if you are really saving any money.
3. It all depends on the future:
According to experts, if you plan to move or upgrade in the next few years, an ARM is a wise decision. Facts remains that you can benefit from a lower rate mortgage and simply sell the home and buy another before the rate adjusts. For instance if are interested in moving out in three years, why not go in for a five-year adjustable mortgage. In that scenario you get a lower rate that won't adjust while you own the home, as long as you sell during the initial rate period.
But before that make sure that the loan comes with no prepayment penalties. Make sure that you do some mathematics, as it is pivotal. It is worth mentioning in this regard that if interest rates go up drastically in those three years, when you buy a new home, you will be facing the higher interest rates. This could clearly leads to the situation in which you will be unable to really upgrade to a larger or more expensive home.
Always remember the fact that Adjustable-rate mortgages are basically all about weighing the risk. It is worth pointing that you are getting a lower interest rate and payment for taking the risk of having to pay a lot more in the future. Few of the homeowners are experiencing this right now as foreclosures are on the rise. On the other hand few homeowners failed to calculate how much their mortgages could adjust to. Majority of them have seen large increases that they are unable to afford. Thats why do all of the math and always prepare for the worst case scenario when considering an adjustable rate mortgage.
In an ideal scenario, Adjustable rate mortgages (ARM) are generally fixed interest rates for a period of time and then become adjustable. In simple terms the introductory interest rate for an ARM loan will be lower than a fixed rate mortgage. If experts are to be believed, this is more or less been done in order to lower initial payments and allow the people to take out larger mortgages, or give them smaller payments for the introductory period. Fact remains that this is attractive to people who may know that their income will be increasing over that period of time.
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