As interest rates rise, ARM loans can mean lower monthly house payments.
With interest rates rising, an increasing number of homebuyers are considering adjustable-rate mortgages (ARMs) to finance their house purchase. That’s because as interest rates go up, so does the monthly payment on new mortgages.
Nearly 9% of mortgage borrowers who applied for a loan in mid-November 2022 used an adjustable-rate mortgage, according to the Mortgage Bankers Association, nearly triple the share who used such loans in 2019.
Adjustable-rate mortgages have advantages that could benefit homebuyers looking to stretch their monthly budgets further, especially during the first few years of home ownership, particularly at a time when both home prices and interest rates are going up. But what are adjustable-rate mortgage benefits?
For example, Fifth Third’s 10/6 adjustable-rate mortgage* could save homebuyers thousands in monthly mortgage payments. The loan has a fixed rate for the first 10 years of loan, and then after that, it can adjust every six months. It allows for a loan-to-value ratio of 90% for loans up to $647,000 and a minimum FICO score of 680. For more expensive homes, Fifth Third offers a 15/6 ARM up to $3 million.
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Here’s what you need to know if you’re considering an adjustable-rate mortgage:
1. Is an ARM Loan Right for You?
The appeal of ARMs right now is that they’re offering introductory rates that are significantly lower than those of traditional 30-year fixed-rate mortgages. Those rates can change over time. According to the Mortgage Bankers Association, in December, 2022 the average rate on a 30-year conforming mortgage was 6.20% compared with 5.44% for a 5/1 ARM, three-quarters of a percentage point higher and costing consumers $200 a month more for a $400,000 mortgage.
Once the fixed period of an ARM ends, the rate adjusts, so it could increase or decrease depending on market rates at that time. While ARMs may make sense for many types of borrowers, they are worth considering if you fall into one of the following categories:
- You’re buying a starter home. If you’re planning to move before the fixed period on an ARM expires (or shortly thereafter), using an ARM could allow you to build equity at a lower interest rate while potentially saving money for your next house.
- You expect to pay off your mortgage early. The lower interest rate and lower payment could allow you to put additional cash toward your principal during the fixed-rate period of the ARM.
- You’re planning to retire soon. If retirement is also going to mean a move, whether to downsize or to relocate, you can also benefit from the lower rate now, knowing that you’re likely going to sell your home before the rate resets.
2. Understand How ARMs Work
True to their name, ARMs adjust their interest rate over time, typically after a set period of five, seven, or 15 years. After that introductory period, depending on the terms of the loan, the interest rate (and your corresponding payment) will vary each year, typically based on a benchmark index, such as the Secured Overnight Financing Rate or the yield on a Treasury bill.
That means that if interest rates are higher when your loan adjusts, your payment could go up (and if rates are lower, your payment could go down). By contrast, the payment on a fixed-rate loan will never change due to an increase or decrease in your interest rate.
In addition to knowing the starting interest rate on your loan, you’ll also want to know when the rate will start to adjust, how often it will adjust, and the amount by which it could change. All ARMs have an initial period in which the rate does not change and an adjustment period during which the rate changes on a regular basis.
3. Risks of ARM Loans
When you use an ARM, you’re exchanging lower payments now for the potential to owe higher payments in the future. If rates go up when your rate begins resetting, you could end up paying more over the life of your loan than you would have by using a traditional, fixed-rate mortgage from the outset.
If you’re considering an adjustable-rate mortgage, you will want to be sure you understand when and how your rate could change—and what that will mean for your monthly payment. Typically, there’s a cap on how much your interest rate can adjust each time it resets as well as how much it can change over the life of the loan. Once you know how much your monthly payment could go up, you can plan to adjust your budget to cover the higher bill.
To find out more about a Fifth Third 10/6 ARM*, contact a Mortgage Loan Originator here.