Mortgage rates are extremely low. If you are considering selling your house or are in the market for a new place, there is no time like the present.
When it comes time to qualify for a mortgage, buyers should know that they have plenty of options. The safe mortgage, also known as the conventional mortgage, is the one your dad probably recommends. We all know this one. You make the same monthly payments over the life of the loan. There are no surprises. But did you know that there are all types varying mortgages available in the marketplace today?
Also known as the adjustable-rate mortgage, this unconventional type can serve many types of buyers across all platforms. There is only one advantage when considering this type.
The only reason you would ever want to engage in an ARM is for its lower interest rate. This means you pay less interest towards your balance each month and more principle.
Yeah, there are plenty of detractors. That is why we are going to cover exactly what you can expect with this type of financial tool.
If you entered into an ARM in the last decade you would be sitting pretty. Rates have been so low for so long, that you certainly have enjoyed your low payments. An adjustable-rate mortgage can go up or down. It is tied to an “index”.
You Move Rather Quickly
ARM’s also are for people who don’t stay long in one place. Many of us move fast. Whether it’s for a job, or you just tend to relocate, then this can be for you. Many homeowners know for certain that they will only be in the house for 3-5 years. This is when an ARM can be most valuable without much risk.
Now let’s get into some real-world examples that can explain to you, the consumer, how this can affect you. Here are some of the most popular options.
But before we get started, almost all ARM’s have an initial period whereby the rate cannot change. This can be compared to a conventional mortgage. Most of these types will come with 15 and 30-year terms.
The 7/1 ARM
Whenever you start checking out different adjustable-rate mortgages, you will see a couple of numbers listed. In this case. The “7” is the length in years that you make fixed monthly payments. No matter how high or low rates go, this won’t affect you.
After the 7th year is completed, then your rate will reset. This will happen each year. So if you stay in your home for 10 full years, your rate will reset after the 7th, 8th, and 9th years.
The 3/3 ARM
In this example, the fixed period of your ARM is for 3 years. For 36 months your rate cannot change. Now beginning the 4th year, your rate resets and remains constant for the next 3 years. That means your new payment will stay fixed for years 4-6.
In this example, rates could surge during year 4. However, since your mortgage already reset, you won’t be affected. However, if rates increased during the later part of year 3, you would be responsible for these increased payments for years 4-6 when the rate did reset. Even if rates then decreased in the latter part of year 4, your actual rate wouldn’t decrease until year 7.
The 10/1 ARM
This may be as close as an ARM can come to a conventional mortgage. Your interest rates are fixed for a full decade or 120 months. After which, your rate will then adjust each year until you pay off the mortgage or sell your home.
Caps and Adjustments
As you probably surmised, the banks aren’t going to give you cheaper rates because they admire you. If rates go up, so will your mortgage. And it doesn’t take much for it to affect your payment. But there are some protections built-in for the consumer.
There are limits on how much rates can go up over the entirety of your loan and each adjustment period. This is to protect both you and the banks. It doesn’t serve them well if you abandon your home or fail to make payments. They want you to be able to cover your mortgage each month.
Who It’s Not For
If you enter into an ARM and rates spike, your mortgage rate will go up. Although there will be caps on your mortgage, this certainly won’t do you any good if you cannot afford the payments.
ARM’s aren’t for people on fixed incomes or those that plan to live in their homes for decades. There is just too much risk for these individuals.
Many clever buyers who feel the value of the home will spike in the near future might enter into a 5/1 ARM. But getting out is harder than you might think.
You want to check your loan documentation for any penalties if you decide to sell or refinance your ARM before it resets.
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