Adjustable-Rate Mortgages: Pros and Cons

When buying a home, looking for financing and loans is like picking an apple from a tree. Once you have plucked it out, you are not sure about how juicy or stale. Similarly, you won't know about different types of mortgage loans without understanding their advantages and drawbacks.

Here, we're talking about one, which is an adjustable-rate mortgage. This loan offers flexibility as it can be adjusted over time. This is the polar opposite of a fixed-rate mortgage, where you, as the borrower, have a fixed-mortgage rate throughout the loan repayment period.

Before choosing an adjustable-rate loan as your property financing method, you would want to know about its types, along with its advantages and drawbacks. That is what we will talk about.

Different Types of Adjustable-Rate Mortgages

An adjustable-rate loan will fluctuate interest rates throughout the entire repayment period. But the question is, can the lenders change the interest rates at the time of their choosing? No, they can't. The interest rate on your adjustable-rate loan remains the same for a specific period.

You must be wondering, "Then why are they called Adjustable?" Well, the reason is that interest rates can fluctuate after a specified time period. Yes, your next question would be, "How will I know about the time period of initial and fluctuating interest rates?"

There are various adjustable-rate mortgage types to dedicate the fluctuation in interest rates. Let's look at some of the common ones.

5/1 ARM

The Five in 5/1 represents the period where the interest rate on your adjustable-rate loan will remain the same. Once that initial five-year period is done, the interest rate can be changed after every year, which is what the one represents.

7/6 ARM

In this type of mortgage-rate loan, your interest rate is locked for seven years. After those seven years, the interest rates can change after every six months throughout the loan repayment period.

3/3 ARM

Your interest rate will be fixed for a period of three years. When those three years are done, the lender can alter the interest rate after every three years over the course of the loan repayment.

Other Types of Adjustable-rate Mortgage

Each adjustable-rate mortgage type has two digits. Fixed interest rate period/period after which the interest rates can be changed.

When you find a lender for an adjustable-rate loan, you ask for the mortgage terms that meet your preferences.

Advantages of Adjustable-Rate Mortgage

As we have discussed the adjustable-rate mortgage types, let's look at some benefits you can enjoy.

Lower Initial Interest Rate

Going for an adjustable-rate mortgage helps you save a lot of money at the start. An adjustable-rate mortgage generally offers a low-interest rate until you are in the fixed-interest rate period. This allows you to reduce your monthly expenses and save a lot of your money.

Monthly Payments Can Be Lower

As the fixed interest rate period ends, your interest rate can drop even more. You can pay off your mortgage faster. Make sure to look at the maximum prepayment clause in your mortgage contract. We will talk about it later on.

Flexibility in Mortgage Payments

Are you planning to live in the house for a limited period before relocating? If so, an adjustable-rate mortgage can be the right option for you. When you think the real estate industry is not looking good, you can sell your house before the adjustable interest rate period starts.

Capping Keeps in Interest Rates in Check

We have already discussed the types of adjustable-mortgage loans. An adjustable-rate mortgage doesn't mean the lenders can change the interest rate as and whenever they want.

Apart from the timeline caps, there are adjustment caps on how much the interest rates can fluctuate.

Generally, there are three adjustment caps that you would want to know about.

Initial Adjustment Cap

This dictates how much the lender can increase your interest rate after the fixed-rate period. For example, if your initial sits at 3% and the initial adjustment cap is 3%, the maximum interest rate you will be charged during the initial period is 6%

Periodic Adjustment Cap

This cap tells you the percentage of how much your lender can increase your interest rate in the adjustment period.

Suppose you have opted for the 3/3 adjustable-rate mortgage. In the first 3 years, you have paid an interest rate of 3%. If the periodic adjustment cap is 4%, your interest rate can reach 7%.

Lifetime Adjustment Cap

What is the maximum interest rate that your lender can charge? You get the answer to that question from the lifetime adjustment cap. No matter the market situation, the lender cannot charge more than the lifetime adjustment cap.

Disadvantages of Adjustable-Rate Mortgage

Let's now look at some potential drawbacks of an adjustable-rate loan.

Interest Rates May Increase

After the fixed interest rate period ends, your interest rate fluctuation depends on the real estate market condition. Your interest rates can significantly increase, which may impact your mortgage affordability.

Unpredictable Interest Rates

As your mortgage rate can unexpectedly change, it will be complicated to budget for the mortgage expense. The reason is you won't know how much finances you need to allocate for your mortgage.

Hard to Understand

Unlike fixed-rate mortgages, adjustable-rate mortgages have consistently changing agreements and complicated terms. First-time buyers may have trouble understanding the adjustable-rate loan technicalities.

That's where having a real estate expert during with you when negotiating the terms of your adjustable mortgage loan.

Prepayment Penalties

Here comes that prepayment point that we briefly touched upon earlier.

Some lenders enforce a penalty to prevent you from paying off 100% of your mortgage early. For example, if you have a seven years prepayment penalty clause, and you want to sell your home before that, you may have to pay extra money to do it.

Yes, we mentioned earlier that an adjustable-rate loan is flexible. That's because, unlike the fixed-rate mortgage, this is optional in the adjustable-rate mortgage. Lenders can waive this condition in the mortgage contract.

So, it's important to read the conditions carefully before you sign it.

Wrapping it up

So, now that you know more about the adjustable-rate loan better, followed by its pros and cons, do you think it meets your requirements?

If it does, the next thing you need after finding a lender is to start the hunt for your dream home, and HAR will help you with that. Our real estate agents understand your preferences and find you the residents that you are looking for.