Whether you’re buying your first home, trading up, or refinancing, you’ll have two primary mortgage options: a fixed-rate mortgage or an adjustable-rate mortgage. Which type is right for you will depend on things like how comfortable you are with risk and how long you plan to stay in your home.
Here are some things you should know about an adjustable-rate mortgage to make the best choice for you.
What Is an Adjustable-rate Mortgage?
Just like it sounds, an adjustable-rate mortgage, or ARM, is a mortgage with rates that can change from time to time. The payments are usually based on a set rate for a specific period of time — often three or five years. After that, the rate (and monthly payment) can fluctuate. In contrast, a fixed-rate mortgage has the same rate over the entire life of the loan.
One potential benefit of an adjustable-rate mortgage is that the interest rate for its beginning fixed-rate period is typically lower than the rate for a traditional fixed-rate mortgage.
In general, an ARM’s fluctuating rate is partly based on a standard index, and it can go up or down depending on the index. That’s one potential downside to an adjustable-rate mortgage: The rate can rise unexpectedly after the initial fixed-rate period.
It’s vital that you understand the period and lifetime loan caps on your mortgage. “There can be caps on the rate fluctuations,” says Lara H. Smith, who handles mortgage product management and credit administration for Regions Bank. “And if this is the case, it usually means that each year there’s a minimum and a maximum beyond which the mortgage rate can’t increase or decrease.”
Is an Adjustable-rate Mortgage Right for You?
The choice between a fixed- and adjustable-rate mortgage will depend on a variety of factors. However, Smith, cites two main situations in which getting an ARM can be especially beneficial:
- You don’t plan to stay in the house very long: “How long you’ll be in your home is a very important factor to consider,” she says. Maybe you often move for a new job , or maybe you’re a newlywed buying a starter home with your spouse. Either way, if you anticipate moving before the fixed-rate period ends and expect that your house will sell at the desired price without issue, you can gain all the benefits of a low-interest ARM without shouldering the risk of a fluctuating rate.
- You’re refinancing: If you’re refinancing a mortgage with a high interest rate and don’t plan to be in your home for more than 10 years, an ARM may be a good option because ARM rates are traditionally lower than fixed mortgage rates.
That said, plans can be derailed, and a life situation can prevent you from moving out in the time period you anticipated. So even if you expect to move before the fixed term ends, make sure you can afford the payments — and any fluctuating rates — if you stay longer.
“It really pays to be completely aware of what your rate can be when the fixed-rate time period ends,” Smith says. “That will help ensure you can make your payments when your rates start fluctuating.”