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What is an adjustable-rate mortgage? Learn the pros and cons

Wondering if an adjustable-rate mortgage is right for you? Here's everything you need to know about ARM loans! Keep reading!

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Understanding adjustable-rate mortgages

Adjustable Rate Mortgage ARM abbreviation on wooden blocks and hand
Learn what an adjustable-rate mortgage is. Source: FreePik

Are you considering buying a house but unsure which type of loan to get? If so, it’s time to explore what an adjustable-rate mortgage is!

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ARMs can offer homeowners certain benefits, such as lower interest rates, in exchange for taking on more risk. Read on and learn how an ARM can get you closer to achieving your home dream. 

What is an adjustable-rate mortgage?

There are many reasons to consider getting an adjustable-rate mortgage when deciding on which loan to get.

They can offer lower interest rates and other reduced fees. But it is important to remember that some risks are associated with using an ARM.

In short, an Adjustable-Rate Mortgage(ARM) is a home loan with a variable interest rate. Rates are fixed during a pre-established period, then change through an index.

The rate can change after the initial period ends, so you’ll pay more or less over time!

Because of their characteristics, ARMs also can be a powerful tool for homebuyers who wants to keep a loan for a limited time.

Terms

Terms will vary from lender to lender, but ARMs tend to have more flexible terms. It can be of 15, 30, or even 40 years terms, also changing according to its type.

Regarding the ARM first period, when the interest rate is fixed, you must expect it may vary its duration between three to 10 years.

Difference between an adjustable-rate mortgage and a fixed-rate mortgage

Woman's hand showing keys from new apartment
Difference between an adjustable-rate mortgage and a fixed-rate mortgage. Source: FreePik

First, you must know that with an ARM, the rate is fixed for a pre-settled period. After that, the rate can vary, leaving you paying more or less on your loan than before.

After the first fixed-rate period, the rates will vary according to a fluctuating benchmark rate that normally mirrors the general state of the country’s economy.

Therefore, they’re also known as “floating mortgages.” So, it’s essential to be aware and assess ahead of time if you can manage financially the potentially higher rates.

Despite variables,  there is a limit on the highest possible rate you can pay on an ARM. On the other hand, the main characteristic of a fixed-rate mortgage is the fixed interest rate!

It grants the borrower predictability about the amount paid to the lender. Commonly, fixed-rate mortgages have higher interest rates and fees when compared to ARMs.

Adjustable-rate mortgage pros and cons

The interest rate of an ARM can change based on the performance of an established index plus a fixed and contractually pre-defined margin(ARM margin) added by the lender.

This way, adjustable-rate mortgages offer flexibility at the cost of not offering predictability about the amounts that will be paid.

Furthermore, despite variables,  there is a limit on the highest possible rate you can pay on an ARM. Check some of their pros and cons below.

Benefits

  • Advantageous for short-term borrowing;
  • No refinance is needed;
  • It can help you save money;
  • Allows you to direct money to other goals.

Downsides

  • It’s harder to understand the options and how it works;
  • Very low predictability compared to fixed-rate mortgages;
  • Monthly payments may increase highly due to rate hikes, even with a cap limit.

Types of adjustable-rate mortgages

There are normally three types of ARM, each with its advantages and disadvantages. It can be Hybrid, Interest-Only, and Payment-Option. See more details below!

Fixed Rate Mortgage is shown on the business photo using the text

Fixed-rate mortgage: what it is, pros and cons

Keep reading and learn what a fixed-rate mortgage is and whether it is the right option for you! We'll explain everything you need to know.

Hybrid ARM

The Hybrid is the most traditional ARM and is a mix of fixed and adjustable-rate period mortgages that we covered earlier.

When contracting the loan, a defined period is set for the interest rate to be fixed. After that, rates will float according to a benchmark plus the lender’s ARM margin.

Furthermore, the Hybrid ARM will also have a pre-established duration and adjustment of the frequency that the interest rate varies before taking out the mortgage.

Interest-Only (I-O) ARM

When contracting an interest-only ARM, the borrower will pay only the mortgage’s interest during a defined time.

After that period, which typically varies from three to 10 years, the applicant starts to pay both interest rates and the loan’s principal.

This modality of ARM costs less to the borrower in the first years. It normally allows you to save money and direct funds to other opportunities.

Payment-Option ARM

As its name says, the payment option is a modality of ARM in which borrowers can choose between various options to pay off the loan.

Generally, it consists in selecting a payment schedule, such as interest-only; principal and interest; 15-30 or 40-year terms; or paying a minimum payment.

But it is not all roses! You must be aware that payment-option ARM may increase your loan balance if you aren’t paying enough to cover the interest by choosing some of its options.

How to apply for an adjustable-rate mortgage?

Happy couple writing notes while going through home finances dur
Learn how to apply for an adjustable-rate mortgage. Source: FreePik

First, check rates, terms, fees, and other conditions the lender may offer to guarantee that your home dream does not transform into a nightmare.

After, you can consider making an application. Some lenders offer prequalification online with a soft credit check if you’re concerned with your credit score.

It won’t affect your score and will give you further lender information. Once pre-approved, the next step includes giving additional information and documents, including:

  • Tax returns;
  • Pay stubs, W-1s as proof of income;
  • Bank statements and other assets;
  • Credit history;
  • Photo ID;
  • Renting history.

This documentation will vary from lender to lender, and some will request more! Most of them give a list of documents required through their website.

Should you get an adjustable-rate mortgage?

Buying a house is a major decision, and the type of loan you choose will have lasting effects on your monthly payments, equity, and financial security.

Adjustable-rate mortgages can provide unique benefits that traditional mortgages may not – such as lower interest rates upfront – but this option also comes with certain risks.

It’s important to research and understands ARMs before deciding, consider their advantages and dangers, and weigh them carefully against other types of loans available to you.

The bottom line

If an ARM offers the best fit for your long-term goals, don’t hesitate to take advantage of it! Get an adjustable-rate mortgage today if it’s the best option for you!

Therefore, we brought you a lender that performs as one of the great options for those looking for an adjustable-rate mortgage!

Carrington Mortgage is an excellent choice if you want your housing dreams to come true! Then don’t hesitate to get one! Continue to the next post and learn how to apply today!

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Carrington Mortgage review: rates, terms and more

Looking for a mortgage? Check out the latest Carrington Mortgage review. Enjoy multiple loan options and qualify with poor credit.

About the author  /  Luis Felipe Regueira

I needed to learn about finances when I was in culinary school and wanted to save money to start my own business. So I haven't stopped because I believe studying and writing about the topic can help more people achieve their goals. Currently, I write about finances and run a small coffee shop.

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