As a prospective homeowner, you know you’re looking for the best interest rate possible on your mortgage. But there are other factors to consider, too. While fixed rate mortgages account for the vast majority of home loans in the U.S., there are instances when an adjustable rate mortgage, or ARM, could make more sense for a borrower. Let’s break down what an ARM is, and take a look at some scenarios where this type of home loan could work.
What is an adjustable rate mortgage?
Just like the name sounds, adjustable-rate mortgages are home loans that start with an initial interest rate that is fixed for a certain period of time, but then adjust to a different rate after that.
Many ARMs, according to the government’s Consumer Financial Protection Bureau, will start with a lower interest rate than a fixed rate mortgage (a loan where the interest rate remains the same for the entire duration of the loan term).
With an ARM, after that initial fixed period, your rate will then adjust depending on the market as well as the LIBOR — London Interbank Offered Rate — index. That’s a standard financial index used in the United States. Each adjustment has annual and lifetime caps.
You Don’t Plan To Stay Long
In a similar scenario, homeowners who only intend on staying in a home for a shorter period of time — essentially, before the fixed period of the ARM expires, Fox Business explains, could benefit from an ARM. Just don’t forget to be aware of any pre-payment penalties, a Marketwatch report cautions.
You Want Lower Monthly Payments
According to that same Marketwatch report, an ARM mortgage might also make sense for a prospective home buyer who is looking to buy during a time when conventional interest rates are high. Adjustable rate mortgages have lower introductory rates, which might make sense for someone who is willing to take on the risk of a potentially higher interest rate in the future for the payoff of lower monthly payments in the short term.
You Expect To Earn More In The Future
Another reason an ARM might make sense, according to a 2016 CNBC report, is if you are just starting out in a field where you expect your salary to have risen by the time the lower initial rate period is up. In this scenario, you reasonably expect to be able to handle the adjusted rate, while saving on monthly payments during the time it takes to grow your salary.