When buying a home, it is essential to decide which type of mortgage best meets your needs. You have several options available such as fixed-rate and adjustable-rate mortgages (ARMs).
Both types of loans have their advantages and drawbacks. While ARMs generally offer lower interest rates than fixed-rate mortgages, they may not be suitable for everyone. You should only consider an ARM if you plan to stay in your home for several years and can afford any potential changes in interest rates after the initial fixed period has elapsed.
Adjustable-rate mortgages come in three varieties: hybrid, interest-only and payment option. Hybrid ARMs begin with a fixed interest rate for an established period between 3-10 years before it adjusts according to a preset schedule. On the other hand, interest-only ARMs allow borrowers to pay only interest on their loan for a predetermined amount before having to make full principal and interest payments.
Borrowers typically opt for ARMs due to their lower interest rate. This may be especially attractive to those who don’t plan on staying in their homes long term or are uncertain if they’ll sell before the introductory fixed-rate period ends.
However, a low interest rate can also be a potentially hazardous thing. It could put homeowners in an untenable situation where they cannot make their payments or afford to pay off the loan on time. Without caution, an ARM could become a massive financial liability over its life expectancy.
Fortunately, there are limits that limit how much an ARM’s interest rate can rise. This helps keep your loan payments from becoming too high and damaging your credit.
Some ARMs feature an initial adjustment cap, which limits how much your interest rate can rise the first time it reverts back to an introductory rate. These caps typically range between 2 percentage points or less.
Additionally, many ARMs feature a periodic rate cap, which restricts how much your rate can increase during each adjustment period. These caps may range from 2 percentage points or more but are generally set at 5 percentage points or greater.
Another essential consideration when shopping for an ARM is whether or not your lender has a lifetime cap on the interest rate. This cap prevents the rate from increasing throughout the life of your loan, effectively preventing an abrupt spike in your monthly payment over time.
When selecting a mortgage, buyers should also take into account how much money they need to put down toward it. If you have significant equity, you may be able to pay down the balance more quickly.
Katrina Wooten of Gainesville, Florida wants to purchase a home but doesn’t want to put her finances at risk by signing on for an expensive high-payment mortgage that could become more costly as rates increase. Instead, she is exploring the possibility of an adjustable-rate mortgage as a way to secure a better loan for herself.