Adjustable-rate mortgages, where the interest rate is subject to change according to market fluctuations and terms, may make certain borrowers wary, particularly following the Great Recession. But there are times when this mortgage type may be right for you.
Here are some things to consider if you’re looking for a short-term home loan and are on the fence about what mortgage to apply for.
ARMs vs. Fixed Rate Mortgages
The mortgage king is still the plain old 30-year, fixed-rate mortgage. The payment on this mortgage type remains constant over its 360-month life, with no changes. It’s measurable and gives homeowners the ability to plan their finances around a set payment.
The 30-year fixed rate mortgage is also the most expensive mortgage. What makes the 30 year loanpricey is its 360-month term. The longer the term of a mortgage, the more interest you’ll pay over time. Conversely, on a shorter loan, you pay quite a bit less in interest.
The adjustable-rate mortgage offers a teaser rate for a certain introductory period, typically in increments of 3, 5, 7 or 10 years. The loan rate becomes variable after the teaser period ends — at that point, the interest rate is based on a fully indexed rate and changes usually about once per year.
The fully indexed rate is computed by adding an index, like the 12-month London Interbank Offered Rate, to a margin, say at 2.25. These factors vary from lender to lender. However, as an example, if you took out a 5/1 ARM, the first five years could feature a teaser rate at 2.875%, while the remaining 25 years of the 30-year term would be variable.
ARMs do contain annual caps and life caps, disclosing just how much your rate and payment could go up annually and over the term of the loan.