When interest rates are on the rise, it’s not all bad news for homebuyers. With the surge in interest rates, many forecast an uptick in housing inventory, less competition for homebuyers, and an increased interest in mortgage solutions that have recently been neglected – like the adjustable-rate mortgage. (ARM).
Every homeowner or homebuyer is different and when it comes to securing a loan it’s important to understand all available options. Here we give a deeper dive into the details of an adjustable-rate mortgage and how it may help a homebuyer save money on a loan, especially if they only plan to live in the home for only a few years.
What are the differences between an ARM and a fixed-rate mortgage?
The primary differences between ARMs and fixed-rate mortgages are found in their interest rate structure:
- A fixed-rate mortgage offers the homebuyer an interest rate that will remain constant over the term of the loan, providing the predictability and security many homebuyers prefer.
- An ARM typically offers a lower initial interest rate but presents the homebuyer with the possibility of higher rates during each scheduled rate adjustment period over the term of the loan.
What is an adjustable-rate mortgage?
An adjustable-rate mortgage (ARM), sometimes referred to as a variable-rate mortgage, is a home loan with a variable interest rate. Most ARMs use a hybrid model combining a lower initial interest rate followed by scheduled rate adjustments over the remaining term.
How does an ARM work?
Most ARMs feature an initial fixed rate for a defined period, followed by rate adjustments, up or down, on a scheduled basis. These adjustments are calculated using an independent financial rate index such as the Secured Overnight Financing Rate (SOFR) plus a lender-defined margin that is established at loan initiation. Most ARMs include rate-change caps per adjustment period as well as for the full term of the loan.
What are the different types of ARMs available?
There are several types of ARMs available — the most common being 3/6, 5/6, 7/6, and 10/6. The first number represents the period during which your interest rate will be fixed. The second number represents how often your interest rate can change after the fixed period expires.
- 3/6 ARM
An ARM featuring a fixed interest rate for the first three years (“3”) followed by adjustments on a semiannual basis (“6”) over the remaining term.
- 5/6 ARM
A five-year fixed-rate period followed by semiannual adjustments over the remaining term.
- 7/6 ARM
A seven-year fixed-rate period followed by semiannual adjustments over the remaining term.
- 10/6 ARM
A 10-year fixed-rate period with semiannual adjustments thereafter.
After my fixed-rate period, what happens to my interest rate?
Following your fixed-rate period, your interest rate can increase or decrease each year for the remaining years of the mortgage. However, caps are set on your ARM to protect against these potential increases.
- An initial adjustment cap limits how much your rate can increase the first time it adjusts. For example – the initial cap on a standard 5/6 ARM is 2% – meaning your interest rate cannot increase by more than 2% at your first adjustment period.
- A periodic cap limits how much your rate can adjust at specified adjustment dates.
- A lifetime cap limits how much your rate can increase over the life of your loan.
Why should I consider an ARM?
Many homebuyers are attracted to ARMs because of the benefits they provide during the initial fixed-rate period, such as:Remove featured image
- Lower loan payments
- Ability to apply initial savings to other needs
- Lower overall loan cost if the consumer plans to sell/move to a larger home before a scheduled rate adjustment (Note: Some ARMs include an early payoff penalty)
- Possibility of additional savings if rates are adjusted downward
A qualified mortgage broker or mortgage lender can help you determine if (or if not) an Adjustable-Rate Mortgage is right for you. If you need a referral for a mortgage broker or mortgage lender, I’m happy to share my list of preferred providers with you. Contact me, Lucinda Layton, at 408-748-4040 or Lucinda.Layton@cbnorcal.com. Or, you can drop your questions below!