If you’re considering an adjustable-rate mortgage (ARM), it’s important to understand how they work and what your options are for getting the best rate. In this blog post, we’ll explore adjustable-rate mortgages, how they work, their pros and cons, and what you need to know before applying. We’ll also provide some tips on how to get the best rate on an adjustable-rate mortgage.
Adjustable-Rate Mortgages: How They Work and What You Need to Know.
An adjustable-rate mortgage (ARM) is a type of mortgage in which the interest rate applied to the borrowed funds is not fixed, but instead is adjusted periodically according to any number of predetermined indices. The most common ARM in today’s market is the 5/1 ARM, which has a fixed interest rate for the first five years of the loan, and then an adjustable rate that changes annually for the remaining term of the loan.
The interest rate on an ARM is calculated by adding a margin to an index. The margin is a set percentage rate that does not change over the life of the loan. The index is usually based on movements in short-term interest rates, such as those published by the Federal Reserve Board in its “Federal Funds Target Rate” or “Discount Rate.”
For example, let’s say you take out a 5/1 ARM with a margin of 2.5%. This means that your interest rate will be 2.5% higher than whatever the current federal funds target rate happens to be when you close on your loan. If that target rate is 3%, then your initial interest rate will be 5.5%. If it goes up to 4%, then your interest rate will adjust upward to 6.5%.
The most important thing to remember about ARMs is that they typically offer lower rates than fixed-rate mortgages, at least at first. So if you plan on owning your home for only a few years, or if you expect rates to rise in the near future, an ARM could save you money on your monthly payments – but only if you are comfortable with taking on some risk.
The Pros and Cons of Adjustable-Rate Mortgages
There are both pros and cons to consider when taking out an adjustable-rate mortgage:
Pros:
- You may qualify for a larger loan amount than you would with a fixed-rate mortgage, since ARMs are often offered with lower “teaser” rates initially;
- Your monthly payments will be lower at first, since teaser rates are usually lower than fixed rates;
- You have more flexibility when it comes to choosing how long you want your loan term to be; and
- You can benefit from lower interest rates if they go down during the life of your loan (although this also means that you could end up paying more if rates go up).
Cons:
- Your monthly payments could go up – sometimes significantly – after the initial teaser period ends;
- You may not qualify for certain types of refinancing if rates have gone up since you took out your original loan; and
- You may end up paying more in total interest over time if rates rise during the life of your loan.
How to Get the Best Rate on an Adjustable-Rate Mortgage
When it comes to getting the best rate on an adjustable-rate mortgage, you’ll want to shop around. Start by talking to different lenders about their rates and terms. You can also use an online mortgage rate tool to compare rates from multiple lenders. Be sure to compare apples to apples, though, so you’re really comparing the same thing. For example, if one lender is offering a lower interest rate but has higher fees, you might not be getting the best deal after all.
Compare Lenders’ Terms and Conditions
It’s not just interest rates that you should be comparing when shopping for a mortgage. You should also compare the terms and conditions that each lender offers. Some things you might want to look at include:
- Prepayment penalties – Some lenders charge a fee if you pay off your loan early.
- Origination fees – This is a fee charged by the lender for processing your loan application.
- Discount points – These are upfront fees that can lower your interest rate but increase the overall cost of your loan.
- Loan terms – The term of your loan is how long you have to repay it. ARMs typically have shorter terms than fixed-rate mortgages, so make sure you’re comfortable with the length of time you’ll be making payments before committing to a loan.
Get Pre-Approved for an Adjustable-Rate Mortgage
Once you’ve compared rates and terms from different lenders, you’ll want to get pre-approved for an adjustable-rate mortgage (ARM). Getting pre-approved means that a lender has reviewed your financial information and is willing to give you a loan up to a certain amount at a particular interest rate. This can give you some negotiating power when it comes time to sign a contract for your new home since you know exactly how much money you have to work with.”
How to Make an Adjustable-Rate Mortgage Work for You
When you are choosing the term of your adjustable-rate mortgage, you should consider both the initial rate and how long that rate will last. The initial rate is usually lower than the rates on fixed-rate mortgages, but it will only last for a set period of time—usually five, seven, or ten years. After that, the interest rate will adjust annually, based on market conditions.
To get the best deal on an adjustable-rate mortgage, you should choose a loan term that is as short as possible. That way, you will pay less interest over the life of the loan. For example, a five-year adjustable-rate mortgage will have a lower interest rate than a seven-year mortgage—but it will also adjust sooner. So if interest rates rise in the future, your payments could go up more quickly with a five-year mortgage than with a seven-year mortgage.
Make a Large Down Payment.
Making a large down payment is one way to make an adjustable-rate mortgage work for you. A larger down payment means that you will have equity in your home from day one—which can help if you need to sell your home before the end of your loan term or if you want to refinance at a later date.
If you can afford to make a large down payment, it’s worth considering an adjustable-rate mortgage even if you think interest rates may rise in the future. Just be sure to budget for potential increases in your monthly payments down the road.
Pay Off Your Mortgage Early
Another way to make an adjustable-rate mortgage work for you is by paying off your loan early—if possible. Most adjustable-rate mortgages have provisions that allow you to do this without penalty—so if you come into some extra money (from selling another property, for example), you can apply it toward your principal and save yourself some money in interest charges down the road.
Conclusion
If you’re considering an adjustable-rate mortgage, it’s important to understand how they work and what the potential risks and benefits are. Shopping around for the best rate is essential, and it’s also a good idea to get pre-approved before you start house hunting. To make an adjustable-rate mortgage work for you, choose the right loan term and make a large down payment. You may also want to consider paying off your mortgage early.