At first glance, an adjustable rate mortgage, also known as an ARM, can be quite tempting to potential home buyers and refinancers looking for a great rate on their home loan. Even though these adjustable rates come with some nasty side effects later on down the road, they can offer a bit of financial relief to those enduring some troubling times.
On the other hand, fixed rate mortgages offer a sense of stability to those who’d rather do things on a more secure plane, as you’ll never have to worry about your principle and interest increasing without your consent. Tax deductible interest on home loans might simply mean a bit larger return when April rolls around.
In order to assist you a bit more in your research, here are a few of the pro’s and con’s of adjustable rate mortgages so you can decide for yourself which one is best for you.
The Pro’s of an Adjustable Rate Mortgage
- Lower rates and payments early in the terms of the loan. An ARM may look like this : 1/29, 2/28. The first number reflects the number of years the interest rate will stay the same on the loan, while the second refers to the number of years the rate will adjust.
- The lower rate yields a higher mortgage payment amount, meaning that the borrower can afford a higher loan amount.
- ARM’s offer a cheap option for borrowers who don’t plan on living in this particular house for very long.
The Con’s of an Adjustable Rate Mortgage
- The rates and accompanying payment can (and will) rise significantly over the life of the loan, as the rates of mortgages do not follow along with the rest of the interest rates for auto and personal loans. ARM’s increase an average of 3% after the initial rate period expires, depending on your program for one year, and then can increase again at the end of the next year.
- ARM rates are initially set low to draw in potential customers. Lenders of ARM’s have more flexibility when determining all of the “mortgage” things like margins and adjustment indexes, setting some uneducated borrowers up for some shady lending tactics, including outrageous fees disguised as points among others.
- More than likely, you will have to refinance this mortgage before the rate expires, but after the prepayment penalty is up (if allowed by state law), so the window of opportunity is a small one. When you refinance your home, you will yet again have to pay an average of $4,000 in closing costs- not including lender fees. If you do the math and refinance your mortgage every 2 years, you’ll be paying quite a bit in fees and associated costs- fees that are eating up the equity in your home.
Finally, with the housing market teetering in many areas of the country, you may not be able to refinance out of a 2/28 ARM quite as easily as you might hope. If the equity level in your home slips to an unfavorable level, you may only be able to refinance to another 2/28 ARM. In two years, you’ll be in the same exact situation, except you’ll have paid another round of closing costs as you refinanced your adjustable rate mortgage, and maybe a bit wiser for your troubles.
