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You have quite a few mortgage options when buying a home in Washington State. One of your primary choices has to do with the interest rate structure. Do you want to use a home loan with a fixed or adjustable rate?
Today, we will look at the pros and cons of using an adjustable-rate mortgage (ARM) loan when buying a house in Washington.
But before we get to the pros and cons, we need to talk about what an adjustable-rate mortgage is, and how it works.
What Is an ARM Loan?
As its name suggests, an adjustable mortgage has an interest rate that can change over time. Usually, these changes or “adjustments” occur once per year, following an initial phase where the rate remains fixed.
For example, a “5/1” ARM loan starts off with a fixed mortgage rate for the first five years. That’s what the number 5 signifies in the name. After that five-year period, the rate will begin to adjust annually — or every “1” year. Hence the term 5/1 ARM loan.
That’s just one example. These mortgage products come in many forms.
The adjustable nature of these home loans distinguishes them from fixed-rate mortgage loans, which carry the same rate of interest for the entire repayment term.
You might wonder why a person would want to use a mortgage product with an interest rate that can change over time. Why would a borrower seek such a loan in the first place? To answer that question, we have to move on to the pros and cons part of our discussion.
Pros and Cons for Washington Home Buyers
The pros and cons of using an adjustable-rate mortgage to buy a home in Washington can be summed up in a single sentence:
You can save money during the first few years, but you’ll face the uncertainty of a changing interest rate beyond that initial period.
If you look at any mortgage rate survey, such as the one conducted by Freddie Mac, you’ll notice that the ARM loans usually start with a lower interest rate than their fixed-rate counterparts.
For example, here are the average rates for different loan products when this article was published in August 2017:
- 30-year fixed: 3.82%
- 5/1 ARM loan: 3.14%
That’s a difference of 68 basis points, or 0.68%.
This is the primary advantage of using an ARM loan to buy a house in Washington, and it’s what attracts most borrowers to these products in the first place. People who use adjustable mortgages are often able to secure a lower interest rate during the first few years, which can result in a lower monthly payment.
Those of the pros of using ARM loan. There are some disadvantages or “cons” as well.
The primary disadvantage is that the interest rate will start to change (annually in most cases) once the initial phase has expired. In the case of a 5/1 ARM loan, the rate will begin to change every year after the first five years have passed.
Washington State ARM loans are usually tied to a specific “index” such as the London Interbank Offered Rate (LIBOR). So the homeowner’s rate might go up or down after the initial phase, depending on market trends at the time of adjustment.
There are usually caps that limit how much the rate can increase from one adjustment to the next, and also over the “life” of the loan. But there are different kinds of adjustable-rate mortgages with different features, so you have to understand how your particular product will work over the long term.