Homebuyers can choose between a mortgage with a fixed rate and one with an adjustable rate. In many cases, a fixed-rate mortgage is a better option since it provides predictability, but an adjustable-rate mortgage, or ARM, may be right for you if you will only live in your home for a short period of time.
How Does an ARM Work?
With an adjustable-rate mortgage, there is a period of time at the beginning of the repayment term when the borrower has a consistent, low interest rate. The rate and the time period depend on the lender and the loan option the borrower chooses.
An adjustable-rate mortgage is tied to an index. After the introductory period ends, the interest rate adjusts periodically. That means that monthly payments may go up or down, by a little or a lot, depending on market conditions.
Why Might an ARM Be a Good Idea if You Will Move Soon?
For many homeowners, an adjustable-rate mortgage is too risky for their liking. The possibility that their payments might suddenly skyrocket tends to make people nervous. That’s why homebuyers often choose a mortgage with a fixed rate.
If you purchase a house knowing that you will only be there for a relatively short amount of time, an adjustable-rate mortgage may be a better option for you. Since it has a low introductory rate, you will be able to enjoy low payments while you live in the house, as long as you select a loan with an introductory rate that will last at least as long as you plan to stay in your home. If you sell your house before the rate adjusts, you will be able to avoid a steep rise in payments.
What Problems Might You Encounter?
Some mortgages, including ARMs, have a prepayment penalty. A borrower who pays off a loan early or refinances may have to pay a fee. If you decide to take out an adjustable-rate mortgage and you anticipate moving before you pay it off, make sure the lender you choose won’t charge you a prepayment penalty.
Timing the sale of your house right will be critical to avoid getting stuck with higher payments, but there are many factors beyond your control. If you decide not to move or can’t sell your house before the interest rate adjusts, you may have to make higher monthly payments. If you don’t have room in your budget, you may fall behind and wind up in foreclosure or you may be forced to make painful cuts in other areas to afford your mortgage.
Refinancing may be an option, but there is no guarantee that you will get approved or that your payments will go down. If interest rates are higher when you refinance than they were when you took out the mortgage, your monthly payments may even go up. Carefully consider all of this before you choose a mortgage.