With mortgage rates on the rise, more and more homebuyers have been turning to adjustable-rate mortgages (ARMs) also known as variable-rate mortgages because they typically have low introductory rates, which offer significant savings along with other benefits. If you're purchasing a new home or wanting to refinance your current home to lower your payment and improve your cash-flow, consolidate high-interest debt, and/or eliminate mortgage insurance, you may be wondering if an ARM is right for you? To help you make the best decision for your financial needs, we're sharing the ins and outs of adjustable-rate mortgages.
What is an adjustable-rate mortgage?
An adjustable-rate mortgage or variable-rate mortgage is a type of home loan where the interest rate can go up and down after set intervals. Typically, an ARM starts with a lower interest rate (introductory rate or teaser rate) than a conventional mortgage for a certain amount of time. After the introductory period is over, the rate changes periodically based on the terms of the loan.
How does an ARM work?
Unlike a fixed-rate or conventional mortgage, where the interest rate on the mortgage remains the same for the life of the loan, an ARM changes or "adjusts" over time. To better understand how an adjustable-rate mortgage works, let's look at the different types of ARMs — hybrid, interest-only, or payment-only.
The most traditional type of ARMs, Hybrid ARMs have a fixed-rate period and adjustable-rate period — with the interest rate being fixed at the beginning and adjusting at a predetermined time. The information for Hybrid ARMs are typically shown in two numbers. In most cases, the first number indicates the length of time the fixed-rate or introductory rate is applied to the loan, while the second refers to the duration or adjustment frequency of the variable rate.
For example: Members First Credit Union of Florida's 5 Year ARM is a true 5/5. This means that members will receive the introductory rate for 5 years, after which the rate could potentially adjust by no more than 2% up or down depending on what the Federal Reserve 5-year Treasury Constant Maturity is at that time every five years.
If you've been shopping around, you may have also come across an Interest-Only (I-O) ARM. With an I-O ARM, you make interest-only payments on the mortgage for a specific time frame. Once that period ends, you are then required to pay both interest and principal on the loan. This type of ARM is appealing for some because they can start with a low monthly payment. However, the longer the I-O period, the higher your payments will be when it ends. Additionally, by not paying on the principal balance, equity in the home will not be earned during the loan's introductory period.
Payment-only ARMs have several payment options. These options typically include covering principal and interest, paying down just the interest, or paying a minimum amount towards principal and not interest. Opting to pay the minimum amount or making interest-only payments may sound appealing, but making small payments for too long could put you on a slippery slope of debt that is hard to manage.
After the end of the initial fixed-rate, introductory, or teaser period, ARM interest rates will become variable or adjustable for the remainder of the loan. How much the rate changes is dependent on the ARM Caps. ARM caps are the maximum amount the interest rate can fluctuate up or down and are broken down in three different ways:
- The first rate adjustment immediately after the initial fixed-rate period.
- The subsequent adjusted interest rate caps — the maximum amount the rate can increase periodically throughout the loan.
- The lifetime rate cap. This is the maximum the interest rate can increase during the entire term of the loan.
What are the pros and cons of an adjustable-rate mortgage?
ARMs typically start with lower rates. Adjustable-rate mortgages start with a fixed-rate introductory period that is typically much lower than you'll find with a fixed-rate conventional loan.
Your payments may go up over time. After the initial fixed-rate introductory period, your monthly payment adjusts depending on interest rate indexes. If interest rates rise, your loan's monthly payments would be higher.
ARMs offer more flexibility. If you know that you'll be moving in a few years, for whatever reason, an ARM may be a better option for you. The key is to sell or refinance your home before the introductory period ends. That way, you'll benefit by paying less in interest during the loan's initial fixed-rate period.
The uncertainty of variable payments. Fixed-rate conventional loans offer the comfort of knowing exactly what your loan's monthly payment will be, making it easier to budget.
Your monthly payments may go down over time. Just because the interest rate of an ARM loan adjusts, doesn't mean the rate increases. Interest rates could fall during the variable rate period, which could save you the cost and/or time of refinancing your home for a new term.
ARMs are more complex than fixed-rate mortgages. ARM caps, margins, adjustment indexes, and other confusing terms that come with adjustable-rate mortgages may make it difficult to navigate the mortgage process. However, our experienced lenders at Members First will help you understand exactly how your ARM is structured.
We'll Lend A Helping Hand
To learn more about what makes up an Adjustable-Rate Mortgage at Members First Credit Union of Florida, ask a credit union representative. We'll answer any questions you may have or help you crunch the numbers so you can determine if an Adjustable-rate Mortgage is right for you. Give us a call at (850) 434-2211 or stop by one of our branch locations. You can also contact one of our Mortgage Team members below.
Mortgage Loan Manager
(850) 434-2211 Ext. 171
Mortgage Loan Officer
(850) 434-2211 Ext. 185
Mortgage Loan Processor
(850) 434-2211 Ext. 215
Is one of our Mortgage Team members busy or out of office? Email the Mortgage Group or call us (850) 434-2211 Ext. 842 and our next available team member will be there to assist you.
APR = Annual Percentage Rate. All loans are subject to credit approval. Rates and terms are based on individual credit worthiness. Terms and conditions apply. NCUA Insured. Equal Housing Lender. NMLS# 405711.
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