These days, most home buyers are advised to stick to a fixed-rate mortgage, since the payments are more predictable than with an adjustable rate mortgage. However, when you sign up for an adjustable rate mortgage, the payments are initially quite low before increasing over the subsequent years, based on market interest rates. Over the life of the loan, you typically end up paying less, in total, for an adjustable rate mortgage – though you cannot be sure when payments will increase or by how much. This uncertainty is unsettling to many homeowners, but in fact, there are some situations in which an adjustable rate mortgage is a better option.
Situation #1: You'll only be in the home for a short period of time.
When you sign up for an ARM, there is a set introductory period over which your rates cannot increase. The rates during this period of time are typically well below market value. For instance, if the average fixed rate mortgage is set at 4%, you may be able to find an ARM with a 3% introductory interest rate for 1 year or 2 years. If you know you'll only be in the home for less than the length of this introductory period, then an ARM is a good choice. You'll never enter the period of higher payments, and during the time that you are paying, you'll pay less than you would for a fixed-rate mortgage.
Situation #2: You can afford a larger loan than your income would suggest.
Generally, you can get approved for a larger ARM than fixed rate mortgage. For instance, if you have a $60,000 income, you might get approved for a $150,000 fixed rate mortgage, but a $200,000 ARM. If you can afford more home than your income would suggest, then applying for an adjustable rate mortgage is a way to secure a more expensive home. This may be your situation if you are married and want to buy your home only in your name – not your partner's. You may have 2 incomes and thus be able to afford a larger home than the bank would provide a fixed rate mortgage for based on only one of your incomes.
Situation #3: Your income is low now, but you're confident it will increase.
The payments on an adjustable rate mortgage start off lower than those for a fixed-rate mortgage, but then they increase. If your income is low right now, signing up for an ARM may make it possible for you to afford the payments. Just make sure you're really confident your income will increase in the coming months or years, so you can continue to make payments once the rate goes up. People who often fall into this category are new college graduates with entry level positions and planned promotions, and people who just started a new business that they expect to grow.
Adjustable rate mortgage is not right for everyone. However, if you fall into one or more of the categories above, this style of mortgage may be a wiser choice than a fixed rate loan. For more information, talk to a professional like CU Mortgage Service.