Are Adjustable Mortgages Good or Bad?

Adjustable mortgages can be beneficial to homeowners planning to sell before the rate rises significantly.

Adjustable mortgages can be beneficial to homeowners planning to sell before the rate rises significantly.

Adjustable-rate mortgages can be good or bad. Really, it all depends on individual circumstances and what the investor is trying to get out of the situation. Economic factors also play a vital role. For example, during the housing crisis that began in late 2007, adjustable-rate mortgages lost appeal when many homeowners couldn't afford the increasing interest rates and lost their homes. When housing markets improve, however, adjustable-rate mortgages become a more viable option.

Adjustable-Rate Versus Fixed-Rate Mortgages

In a fixed-rate mortgage, the buyer agrees to an interest rate and repayment plan that remains constant throughout the duration of the loan. Having a guaranteed payment structure can offer homeowners added security and stability in knowing future payments won't suddenly increase or decrease. With an adjustable-rate mortgage, the buyer agrees to a mortgage with a rate that while low at the start may increase over time. The interest rate of a traditional ARM usually resets annually right from the start, but hybrid ARMS are also available where resets occur after three, five, seven, or even 10 years. For example, in a five-year ARM, the buyer will have a low introductory interest rate for the first five years, and then the rate will change on an annual basis thereafter.

Pros of Adjustable Mortgages

Adjustable mortgages are usually quite attractive to buyers because initial interest rates are low compared to fixed-rate alternatives. Since buyers are able to save money, they can often purchase a home with a higher price than what they could have with a fixed-interest loan. Another benefit of adjustable-rate mortgages is the ability to take advantage of falling interest rates without the added costs of refinancing. One situation in which an adjustable mortgage works particularly well is when the homeowner doesn't plan to keep the home for more than a few years. A homeowner who only plans to stay in a home for two or three years can get a three-year adjustable ARM, enabling him to take advantage of a low interest rate without the worry about an increase.

Cons of Adjustable Mortgages

A major concern with adjustable-rate mortgages is the fact that interest rates can significantly increase over the course of the entire loan. If average interest rates rise sharply, it's not unheard of for an initial 5 percent or 6 percent interest rate to more than double over time. Even though some loans have a built-in cap on interest rate increases, the first increase can be exempt from this cap. These factors make budgeting ahead difficult for many homeowners, and many end up losing their homes when they find themselves unable to afford the drastically increased payments.

Refinancing Options

The potential for refinancing is an important consideration. A homeowner may be able to convert an adjustable-rate mortgage to a fixed-rate mortgage if the ARM terms prove undesirable over time. Conversion costs can be quite high, however, and not all loans are eligible. When refinancing, the homeowner often must pay origination fees, application fees, processing fees, settlement charges, appraisal fees, costs of title searches and title insurance fees. Those costs may make refinancing impractical.

 

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