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Benefits and Risks of Adjustable Rate Mortgages

Pros And Cons Of Adjustable Rate MortgagesWhen you are in the market for a new home, you may be faced with numerous options for financing your home. One of the choices you will have to make is whether to apply for a fixed or adjustable rate mortgage.

In some cases, an adjustable rate mortgage may be your best option, but keep in mind, they are not the answer for everyone. Adjustable rate mortgages can be risky for some borrowers and it’s important to understand both the pros and cons.

When To Consider An Adjustable Rate Mortgage

Perhaps one of the best things about ARMs is they typically have a lower starting interest rate and payment than fixed rate mortgages for the first 5, 7 or 10 years of the loan. There are shorter fixed rate durations on ARMs available; however, for most people the risk of the shorter duration ARM is too high to justify the benefit.

ARMs Are Beneficial For Borrowers Who:

  • Anticipate an income increase – for borrowers who are anticipating their income to increase over the next few years, an ARM may be the right option.
  • Will be reducing their debt – those borrowers who have automobile loans or student loans that will be paid off in the next few years may benefit from an ARM which would allow them to qualify for a larger mortgage today anticipating their ability to convert to a fixed-rate mortgage.
  • Have a set time you plan on being in the home – when you anticipate living in a home for a duration less than the fixed portion of the ARM, an adjustable rate mortgage will help you save money on interest. That money can be invested in retirement, education or other real estate.

Adjustable Rate Mortgage Risks

There are a number of different types of adjustable rate mortgages and they are each tied to specific interest rate indexes. While an ARM may offer borrowers some flexibility in terms of initial payments, the downsides cannot be ignored. Some of the cons of using an ARM to finance your mortgage include:

  • Increasing rates – borrowers should carefully review their loan documents to see when and how frequently their interest rates may increase. Some loans adjust annually while other may not increase for three to five years after the mortgage is signed. For borrowers, this means they can anticipate an increase in their monthly payments.
  • Prepayment clauses – oftentimes, lenders include a prepayment penalty with ARM loans which can be devastating for borrowers. Before agreeing to an ARM, make sure you read the documents very carefully to determine how long you need to hold the loan
  • Rate Increases– one of the biggest challenges borrowers face with an ARM is what happens when mortgage rates increase and their loan has adjusted. This can result in payment shock and increase the risk of default.

Borrowers who are searching for the right mortgage should discuss all options with their loan officer. There are specific instances when an ARM may be the best option and there are other times, such as if you plan to stay in your home forever, in which case a fixed-rate mortgage may be your best option. While there are many risky and poor ARM programs available, there are also a few very good options that can save certain people a lot of money as long as it fits within their overall financial and life plans. Call Sammamish Mortgage today to discuss your situation and determine what loan program is the right fit for you and your family.

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