When an Adjustable-Rate Mortgage May Make Sense
Most borrowers are familiar with fixed-rate mortgages, where the interest rate remains unchanged for the life of the loan.
An adjustable-rate mortgage, commonly called an ARM, works differently.
With an ARM, the interest rate is generally fixed for an initial period and may then adjust periodically according to the terms of the loan.
For the right borrower, an adjustable-rate mortgage can be a useful financing option. It may be particularly worth considering if you expect to sell, refinance, or pay down the mortgage before the adjustable period becomes significant.
At Capital Funding Mortgage, we help borrowers throughout Pennsylvania and New Jersey compare adjustable-rate mortgages with fixed-rate alternatives.
I’m John Madden, owner of Capital Funding Mortgage, and I have been helping borrowers with mortgage financing for more than 25 years.
My goal is not simply to show you the lowest initial rate. It is to make sure you understand how the loan works, what could happen in the future, and whether the ARM fits your actual plans.
An adjustable-rate mortgage is a loan in which the interest rate can change after an initial fixed period.
During the introductory period, your rate and principal-and-interest payment are generally fixed.
After that period ends, the rate may adjust at scheduled intervals.
For example, an ARM might have:
The exact structure depends upon the loan program.
ARM terminology can initially look confusing.
For example:
The interest rate is generally fixed for the first five years and may then adjust every six months.
The rate is generally fixed for the first seven years and may then adjust every six months.
The rate is generally fixed for the first ten years and may then adjust every six months.
Other ARM structures may also be available.
The important question is not simply the name of the ARM.
You should understand exactly how long the initial rate remains fixed and how often the rate can adjust afterward.
The main reason borrowers consider an adjustable-rate mortgage is that the initial rate may sometimes be lower than the rate available on a comparable fixed-rate mortgage.
That lower initial rate may result in:
However, the ARM also introduces uncertainty because the rate may change later.
That trade-off should be evaluated carefully.
An adjustable-rate mortgage may be worth considering if you:
An ARM should fit a financial strategy rather than simply being chosen because the first payment is lower.
A fixed-rate mortgage may be more appropriate if you:
There is no universal answer.
The better loan depends upon how long you expect to keep the mortgage and your tolerance for future rate changes.
When comparing an ARM with a fixed-rate mortgage, we look at more than the initial rate.
Important factors include:
For some borrowers, an ARM may offer meaningful savings.
For others, the added uncertainty is not worth the initial rate advantage.
After the initial fixed period ends, the new interest rate is typically based upon:
Index + Margin
The index is a market-based benchmark specified in the loan documents.
The margin is an additional percentage established under the terms of the mortgage.
For example, if the applicable index at an adjustment date were 3.00% and the margin were 2.50%, the calculated rate would be:
3.00% + 2.50% = 5.50%
However, the actual rate is also subject to the loan’s adjustment caps and other terms.
The margin is a fixed percentage that is generally added to the index when the ARM adjusts.
Unlike the index, the margin normally does not change during the life of the loan.
Because the margin can significantly affect future rates, borrowers should understand it before selecting an ARM.
Rate caps limit how much an adjustable-rate mortgage can change.
Depending upon the program, the loan may have limits on:
These protections are extremely important.
Before selecting an ARM, you should understand not only the initial rate but also the highest rate and payment the loan could potentially reach under its terms.
One of the most important questions to ask when considering an ARM is:
What could my payment become if rates increase?
Do not evaluate the loan based only on today's payment.
We can help you review possible future payment scenarios so you understand the risk before choosing the loan.
If a future payment increase would create financial difficulty, a fixed-rate mortgage may be the safer choice.
ARMs can be particularly relevant in jumbo lending.
Because jumbo loan amounts are larger, even a modest difference in interest rate may create a meaningful monthly payment difference.
For example, a small rate difference on a $1,000,000 mortgage has a much larger dollar impact than the same rate difference on a $250,000 mortgage.
That can make ARMs worth evaluating for borrowers purchasing higher-priced homes.
However, the larger loan amount also means future rate changes can have a greater effect on the monthly payment.
Both sides of the equation should be considered.
Suppose you expect to own your home for approximately five years.
If a 7-year ARM provides more attractive pricing than a 30-year fixed mortgage, you may sell the property before the ARM ever reaches its first adjustment.
In that situation, paying a premium for long-term fixed-rate protection may not provide much practical benefit.
However, plans can change.
A borrower expecting to move in five years may ultimately remain in the home for ten.
That possibility should be part of the decision.
Some borrowers choose an ARM because they expect to refinance before the fixed period expires.
This strategy can work, but refinancing is never guaranteed.
Future rates may be higher.
Property values may change.
Income or credit circumstances may change.
Mortgage guidelines may also change.
For that reason, you should be comfortable with the ARM even if refinancing is not available exactly when you expect it to be.
Predicting future mortgage rates is difficult.
Choosing an ARM solely because you are certain rates will decline can be risky.
A better approach is to ask:
The ARM should make sense based on your circumstances even if future interest rates do not move exactly as expected.
Just like fixed-rate mortgages, ARMs may be offered with different combinations of:
A very low ARM rate may require substantial points.
Another ARM may have a slightly higher rate but much lower upfront costs.
Before selecting a rate, we can calculate how long it would take to recover any additional upfront expense.
An adjustable-rate mortgage may also be considered when refinancing.
For example, a borrower may be planning to:
In those situations, an ARM may deserve comparison with fixed-rate alternatives.
However, the refinance should still be evaluated based upon:
Depending upon the lender and program, adjustable-rate mortgages may also be available for certain second homes or investment properties.
The guidelines and pricing can differ from primary residence financing.
If you are financing a vacation home or investment property, we can compare ARM and fixed-rate options when both are available.
Before selecting an adjustable-rate mortgage, you should know:
If you cannot clearly answer those questions, you should not select the ARM yet.
A lower initial payment can be attractive.
But the correct comparison should include:
Sometimes the ARM clearly makes sense.
Sometimes the fixed-rate mortgage is worth paying more for.
The decision should be based on the complete picture.
ARM programs can vary among lenders.
Different wholesale lenders may offer different:
As a mortgage broker, Capital Funding Mortgage works with multiple wholesale lenders.
That allows us to compare available ARM programs instead of relying upon a single bank.
Capital Funding Mortgage assists borrowers throughout the areas we serve in Pennsylvania and New Jersey.
Whether you are buying or refinancing in:
we can help you compare adjustable-rate and fixed-rate mortgage options.
An ARM can be an excellent financial tool when it fits the borrower’s plans.
But it should be chosen because the numbers and timing make sense—not simply because the initial interest rate is lower.
We can compare:
Contact John Madden at Capital Funding Mortgage to discuss adjustable-rate mortgage options in Pennsylvania and New Jersey.
With more than 25 years of mortgage experience and access to multiple wholesale lenders, our goal is to help you understand both the potential benefits and the risks before choosing an adjustable-rate mortgage.
Capital Funding Mortgage
Understand the rate today—and what could happen tomorrow.
