Ask the average homeowner about adjustable-rate mortgages (ARMs) and, if they can tell you anything, they’ll likely just be reciting media stories of the 2008 housing crisis. More than six million homes were affected when mortgage payments spiked to unaffordable levels. It’s natural that fears of subprime shenanigans, soaring costs and spiraling home equity would continue to propagate years later.

But ARMs are not the boogeyman they’re often made out to be. There are situations where an adjustable rate may work in your favor. They’re still misunderstood though, so we thought it worth spending a few minutes to understand how ARMs differ from fixed-rate loans, and how they might serve you and your current (or future) homeownership plans.

What exactly is an adjustable rate mortgage?

You might be used to the more traditional fixed rate loan that sticks to the same interest rate, and monthly payment, for the entire lifetime of the loan. These are the common 10-year, 15-year and 30-year mortgages.  

An adjustable-rate mortgage (ARM) is typically a 30-year home loan that starts off with a lower, introductory fixed interest rate. The introductory rate is set for a defined time period, often 5, 7 or 10 years.

When that period expires, the rate is then adjusted up or down at regular intervals. The interval is determined by the lender and is documented in the terms of your loan. How much your rate is adjusted largely depends on market conditions and other factors, like federal interest rates and benchmark indexes.

These rate adjustments will cause your monthly payment to increase or decrease accordingly. Knowing about the potential changes can help you plan ahead.

When an ARM might be a good idea

What attracts home buyers to ARMs is the low fixed-rate time period. Those first years of lower payments can save you a lot of money!

If you are buying a starter home, with plans to sell and upgrade in a few years, then lower payments help you save up for that move. And the higher monthly cash flow looks good on your next loan application.

If you are buying a home with the intent to pay it off quickly before the rates potentially go up, you can put more towards your principal with the ARM loan than you can with the standard 30-year loan.

Of course, you don’t have to put that savings toward a current or future home. It can go towards other important things in life, like new vehicles, kids' education funds, travel, and so on.

Is there a limit to how high my payments can go?

Contrary to some of the scary stories you may have heard, many ARM loans today have some limits to protect you from financial upheaval. When talking to your banker, ask if the loan has an initial cap, subsequent caps, and a lifetime limit cap.
  • The initial cap limits how much the rate can go up the first time the loan is adjusted following the fixed-rate period.
  • Subsequent caps are similar, limiting how much the rate can raise each time the loan comes due for possible adjustment.
  • The lifetime limit caps the rate that the loan can reach, during the entire lifetime of the loan. In other words, there is a maximum rate you can be charged.
Remember, the market may also move in your favor. If your payments go down, you’ll have some extra cash to tuck away should rates go up next time.

Downsides of ARM loans

One of the worst case scenarios is If your interest rates go up and you aren’t prepared. This is especially true if your loan is through a lender that re-evaluates often. Some do it every six months. Some even do it every month! Starion Bank evaluates once per year.

If rates go up too much for you to afford, you can try refinancing your loan to a traditional fixed-rate mortgage with a more stable payment structure. Keep in mind that you will likely spend more years paying off your home. Also, refinancing is never guaranteed. You’ll need to go through the approval process and credit check again. If you’ve run into credit problems since your original ARM loan, it can affect your ability to qualify for the new loan.

ARMs are also more complex than traditional loans. Adjustment periods, caps and limits make it harder to understand exactly what kind of loan you’re getting, and what to expect down the road. This is where a good mortage officer will sit down with you, explain everything in plain language, and walk you through the possible changes.

So, is an ARM right for you?

Whether an ARM is right for your next loan depends on your long-term intentions. 

If you want to stay in the home for the foreseeable future, with predictable payments for the entire length of the loan, then a traditional fix-rate mortgage is where you should go.

But if your plans are shorter-term, like perhaps you plan to buy a condo or starter home, then sell it in a few years and buy that home you’ve been dreaming of? You might want to consider an ARM.

Another question to ask yourself is if you expect any big life changes in the next several years, such as going back to school or switching careers. Decisions like these can weigh heavily on whether the potential of rate and payment changes might work for or against you.

Most importantly, don’t chase the lower initial payments of an ARM just to get that big dream house sooner. Gambling on rate changes today could spell trouble down the road.

Starion is here to help you plan for success

Starion Bank won’t surprise you with frequent rate changes, because we want you to feel secure in your home and not always on edge about what may happen next month. Your success is our success!

Our mortgage bankers are the best in the business. They have the experience and knowledge to help you find the perfect loan for your needs. They sit down with you, go over all the paperwork, answer all your questions, and make sure you feel good about your decision, no matter what loan type you choose.

Schedule your appointment with a Starion banker today.
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* All offers are subject to credit approval