Introduction
An adjustable rate mortgage (ARM) is a type of home loan where the interest rate can fluctuate over time. Unlike a fixed-rate mortgage, which has a set interest rate for the entire loan term, an ARM offers an advantage of having a variable interest rate. This flexibility can be beneficial for certain borrowers, depending on their financial situation and goals. In this article, we will explore one of the advantages of an adjustable rate mortgage in more detail.
Lower Initial Interest Rate
One of the primary advantages of an adjustable rate mortgage is the potential for a 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 lower initial rate can result in lower monthly mortgage payments, which can be advantageous for borrowers who are looking to save money in the short term.
The lower initial interest rate of an ARM is often referred to as a “teaser rate” because it is designed to attract borrowers. This initial period of lower rates can vary depending on the specific terms of the ARM, but it is typically fixed for a certain number of years, such as 3, 5, 7, or 10 years. After this initial period, the interest rate will adjust periodically based on market conditions and the terms of the loan.
Benefit in a Falling Interest Rate Environment
One significant advantage of an adjustable rate mortgage is its potential benefit in a falling interest rate environment. If interest rates decrease after the initial fixed-rate period, borrowers with an ARM may experience a decrease in their monthly mortgage payments. This can result in substantial savings over the life of the loan.
For example, let’s say you have a 5/1 ARM with a fixed rate for the first five years. If interest rates decline during this period, your monthly payments will remain unchanged. However, once the fixed-rate period ends, the interest rate will adjust annually based on market conditions. If interest rates continue to decrease, your monthly payments will decrease as well, providing you with ongoing savings.
It’s important to note that the opposite can also occur in a rising interest rate environment. If interest rates increase after the initial fixed-rate period, borrowers with an ARM may experience higher monthly mortgage payments. This potential downside is something borrowers should carefully consider when choosing between an adjustable rate mortgage and a fixed-rate mortgage.
Conclusion
The advantage of an adjustable rate mortgage lies in its potential for a lower initial interest rate and the benefit it can provide in a falling interest rate environment. This flexibility can be advantageous for borrowers who are looking to save money in the short term or anticipate a decrease in interest rates. However, it’s essential to weigh the potential risks associated with rising interest rates when considering an ARM.
Ultimately, the decision between an adjustable rate mortgage and a fixed-rate mortgage depends on your individual circumstances, financial goals, and risk tolerance. It is recommended to consult with a mortgage professional to fully understand the benefits and drawbacks of each option before making a decision.
References
– Investopedia: www.investopedia.com/mortgage/adjustable-rate-mortgage-arm/
– The Balance: www.thebalance.com/adjustable-rate-mortgages-315631
