Why take an adjustable rate mortgage (ARM)? Why not just take a fixed rate and not worry about what rates might do in the future?
That’s a fair question, and a good one. Adjustable rate mortgages can be a good choice for borrowers who anticipate financing a property for a relatively short period of time, say three to five years. ARMs can offer lower, “teaser” rates that are usually lower than fixed mortgage rates. And when caps are applied, an ARM may be the better overall choice.
Most ARMs today are fixed for the first few years at a very low rate. This can offer advantages to homeowners in certain circumstances.
These initial “fixed” periods can range from 3, 5, 7 or even 10 years. The loan interest rate then adjusts, usually once per year. These loans, also called “hybrid ARM” mortgages, can make sense depending on your plans over the first 3 to 10 years of the mortgage.
An ARM Might Be a Good Idea When…
Receiving a Windfall
If you plan to receive a large amount of money in the next 5 years or so, an ARM might make sense. Say that you have a piece of real estate with a lot of equity that you plan to sell. Or, you will receive an inheritance. Maybe you will sell your business in 5 years.
In any of these circumstances, you could take a very low initial rate, then pay off the mortgage toward the end of the fixed period.
Selling the Home Early
If you plan to sell the home in the next 5 to 7 years, a ARM might be a good choice. Perhaps you are buying a smaller property, but plan to move into a bigger home as your family grows. Or your job will move you out of the area in the next few years.
In these cases, it might make sense to cash in on a really low interest rate for a few years. Just be careful that your plans are fairly certain. If they’re not, you may want a fixed rate loan or an ARM with a very low rate along with low caps.
You Want a Tax Deduction or will soon Retire
You might have the cash to buy a home outright, but want a short term loan for the mortgage interest tax deduction. Although this website does not give tax advice, it’s a fact that the mortgage interest deduction can have a big effect on the amount of taxes you pay. Check with your tax advisor.
If you make a lot of money now, but will retire in 3 to 10 years, an ARM might make sense. You may be able to use the tax deduction to reduce your current adjusted gross income (AGI) thereby reducing your tax bill.
When you retire and your income decreases, you could pay off the mortgage if you no longer need the tax deduction.
So is an ARM for Everyone?
For most home buyers, a fixed rate mortgage will be the loan of choice since it still offers incredible interest rates and stability for the future.
Still, there are many situations in which an ARM might make sense.
Still have questions about ARMs? Contact one of our licensed mortgage professionals.