As with any loan type, there are a number of advantages and disadvantages to adjustable rate mortgages. Let’s look at the pros and cons of ARMs and compare them to the benefits and drawbacks of fixed rate mortgages.
Pros of Adjustable Rate Mortgages
- Lower rate and payments: With certain types of ARMs, borrowers can lock in a lower interest rate and monthly payments for a number of years. This typically offers borrowers a significant savings over a fixed rate mortgage in that initial period.
- Flexibility: If you don’t plan to stay in your home for 30 years — the traditional length of a fixed rate mortgage — choosing an ARM might make sense. The initially low fixed rate of an ARM that adjusts in three, five, seven, or ten years can help you keep payments low.
- Know the highest potential payment: According to the government’s Consumer Financial Protection Bureau, lenders are required by the Truth in Lending Act to disclose just how much you could pay after the ARM you are considering adjusts. A key advantage to fixed rate mortgages is predictability — but “arming” yourself with this knowledge about your ARM can help prevent sticker shock down the road.
Cons of Adjustable Rate Mortgages
- Rates and payments could go up: As noted above, a key advantage to a fixed rate mortgage is knowing how much you’ll pay for the life of the loan, right from the beginning. With an ARM, your rates and payments can significantly increase over the life of the loan, and could increase from year to year depending on the type of ARM and the current state of the market.
- Less predictability: With an ARM, it is harder to predict a consistent mortgage payment, which can impact a borrower’s budgeting. Even if you planned to move or refinance before the initial lower rate period is up, sometimes life happens and you might need to unexpectedly stay in the home. Also, be aware that some loans may carry pre-payment penalties, according to the CFPB, which could come into play when you sell or refinance. “Typically, a prepayment penalty only applies if you pay off the entire mortgage balance, for example, because you sold your home or are refinancing your mortgage within a specific number of years,” the CFPB say.