Pros and Cons of Adjustable Rate Mortgages
Are you considering an adjustable rate mortgage (ARM)? A mortgage is a huge decision and it's important to know what you're getting into. Here are some pros and cons of adjustable rate mortgages to help you determine whether it's the right option for your Florida home purchase.
What is an Adjustable Rate Mortgage?
Adjustable rate mortgages start off as a fixed rate for a certain number of years and then adjust (up or down) based on the prime rate. The adjustment amount can be capped yearly. It is often described using 3 numbers to represent the fixed years, adjustment period, and maximum percentage change allowed. For instance, a 5-1-1 ARM is fixed for the first 5 years and may adjust every 1 year after that, up to 1% per year. A 7-1-2 ARM is fixed for 7 years and can adjust every 1 year up to 2% each time.
Pros of Adjustable Rate Mortgages
You may be wondering why anyone would select an adjustable rate mortgage when fixed rate options are available. It's simple. Adjustable rate loans often have a lower interest rate than fixed rate options. Here's an example. On a $400,000 loan, if the adjustable rate starts off at 3.5% and the fixed rate is 4%, that would result in a savings of $113.48 per month.
If you are planning to own a particular home for a short period of time, an adjustable rate mortgage might make sense. For instance, if you plan to live in a home for just 3-5 years, getting a 7-1-1 ARM might be worth the risk and would save you money during those few years. Using the sample calculations above, the savings would be $6,809 over 5 years.
Cons of ARM Loans
Now let's take a look at the other side of the argument. Adjustable rate mortgages do have some risk. If you own a home for longer than the fixed period (whether planned or unplanned) and mortgage interest rates rise, your monthly payment could go up significantly. On a $400,000 loan and 3.5%, if your interest rate increased by 1%, you would pay $230.56 more each month. If it increased again the following year by another 1%, you would pay $474.98/mo more each month (compared to the fixed period).
Of course, the interest rate could remain the same or even decrease, depending on market conditions. However, mortgages rates are currently pretty low and the Fed has long stated its plan to increase them over the next year. It's important to keep this in mind.
Risk versus Reward
Ultimately, selecting the right loan option depends on your personal circumstances and home ownership plans. How long do you plan to own your home? Are you likely to refinance in the near future? Will the amount of savings be worth the risk? These are all questions that you must ask yourself.
If an adjustable rate mortgage makes perfect sense given your situation, then you should certainly take advantage of the savings. If there is any possibility that you will keep the loan for an extended period of time OR you cannot afford the potentially higher future mortgage payment, then it's best to take the safe approach. Being an educated homebuyer will help you make smarter decisions for your Florida home purchase. Contact us for additional advice and guidance on buying and selling a home in the Apopka, Florida area.