Introduction
An adjustable-rate mortgage (ARM) is a type of home loan where the interest rate can change periodically over the life of the loan. Unlike a fixed-rate mortgage, which has a set interest rate for the entire term, an ARM offers flexibility in terms of interest rates. In this article, we will explore one of the advantages of an adjustable-rate mortgage.
Advantage of an Adjustable-Rate Mortgage: Lower Initial Interest Rate
One significant advantage of an adjustable-rate mortgage is the lower initial interest rate compared to a fixed-rate mortgage. When you first obtain an ARM, the interest rate is typically lower than the prevailing rates for fixed-rate mortgages. This can result in lower monthly mortgage payments during the initial period of the loan.
The lower initial interest rate of an ARM can be particularly beneficial for homebuyers who plan to sell or refinance their home within a few years. If you anticipate moving or refinancing before the interest rate adjusts, you can take advantage of the lower initial rate without being exposed to potential rate increases in the future.
How Adjustable-Rate Mortgages Work
To understand why an ARM offers a lower initial interest rate, it’s important to know how these mortgages work. Adjustable-rate mortgages typically have an initial fixed-rate period, during which the interest rate remains constant. This period can range from a few months to several years, depending on the terms of the loan.
After the initial fixed-rate period, the interest rate on an ARM adjusts periodically based on a specific index, such as the U.S. Treasury Bill rate or the London Interbank Offered Rate (LIBOR). The adjustment frequency can vary, but common intervals are annually or every six months. The new interest rate is determined by adding a margin, set by the lender, to the current index value.
Benefits of a Lower Initial Interest Rate
The lower initial interest rate of an adjustable-rate mortgage offers several advantages to borrowers. Firstly, it can make homeownership more affordable, especially for those who are stretching their budget to purchase a home. Lower monthly mortgage payments during the initial period can free up funds for other expenses or savings.
Additionally, a lower initial interest rate can enable borrowers to qualify for a larger loan amount. With lower monthly payments, lenders may be more willing to approve a higher loan amount, as the debt-to-income ratio remains within acceptable limits. This can be particularly advantageous for borrowers looking to purchase a more expensive property or in areas with high housing costs.
Considerations and Risks
While the lower initial interest rate of an adjustable-rate mortgage can be enticing, it’s important to consider the potential risks and future adjustments. After the initial fixed-rate period, the interest rate on an ARM can increase significantly, depending on market conditions and the specific terms of the loan.
Borrowers should carefully evaluate their financial situation and future plans before opting for an ARM. If there is a possibility of staying in the home beyond the initial fixed-rate period, it’s crucial to assess whether potential future rate increases are affordable and within budget.
Conclusion
In conclusion, one advantage of an adjustable-rate mortgage is the lower initial interest rate compared to a fixed-rate mortgage. This can make homeownership more affordable and allow borrowers to qualify for a larger loan amount. However, it’s important to carefully consider the potential risks and future adjustments before choosing an ARM.
References
– Investopedia: www.investopedia.com/mortgage/adjustable-rate-mortgage-arm/
– The Balance: www.thebalance.com/adjustable-rate-mortgages-315556
