ARM Mortgage Loans- Pros and Cons

Do Adjustable Rate Mortgage Loans Mean Lower Home Mortgage Payments?

Oct 22, 2009 Asa Ghaffar

An ARM mortgage loan allows a homeowner to benefit from low bank base rates. Find out the advantages and disadvantages of an Adjustable Rate Mortgage loan.

An ARM Mortgage loan has a fixed rate of interest for a set period before adjusting to a new rate based upon the short-term interest rate. The subsequent interest rate paid by the borrower is based upon the new pricing spread. This will be determined by the T&C's of the agreement.

ARM Mortgage Loans

An example of an Adjustable Rate Mortgage loan is a 5/1. This would mean that the interest rate on the loan is fixed for a period of five years before reverting to the short-term interest rate. It is important to take into account the lifetime cap on rates and whether home mortgage payments will remain affordable.

Advantages of ARM Mortgage Loans

Lower interest rate. The rate of interest will often be considerably lower than on the best fixed rate mortgage deal in the short-term. The low ARM mortgage rate can help borrowers who are currently struggling, yet are likely to experience income growth later in their professional career.
Higher loans. The low introductory rate allows a homeowner to borrow a larger sum of money because home mortgage payments are considerably lower.
Falling rates. If the borrower anticipates that interest rates are likely to fall or stay low for a long period of time, an Adjustable Rate Mortgage loan can allow that person to benefit financially.
Hybrid ARM's. A 3/1, 5/1, 7/1 and 10/1 Adjustable Rate Mortgage loan can prove extremely useful for those who know that they will live at a residence for x years. This means that the borrower can enjoy a low fixed rate mortgage before moving on (without penalty) shortly after the short-term rate commences.

Disadvantages of ARM Mortgage Loans

Early refinancing. Whilst it is unusual for an early redemption penalty to be applied once the loan has been in operation for a period of three years, the inability to refinance could prove costly, particularly if the borrower correctly anticipated that interest rates were heading upwards.
Unpredictable home mortgage payments. Unlike the best fixed rate mortgage deal, the rate of interest isn't set. This could make it difficult for those who are on a fixed income to cope with rising repayments when bank base rates start to go up. Foreclosure rates have always been a lot higher on ARM's than fixed-rate deals.
Long term cost. Whilst the introductory rates are lower than on a fixed rate loan, an ARM mortgage loan could actually cost the borrower more over the full duration.
Confusion. The way that an ARM operates can prove extremely confusing for first-time buyers.

An ARM mortgage loan enables the borrower to benefit from low home mortgage payments in the short-term. However, locking in to the best fixed-rate mortgage deal over a 15 or 30 year term can protect a homeowner against interest rate fluctuations.

Sources

Taylor, Don. (Oct 6, 2004). "Pros and cons of adjustable-rate mortgages." BankRate.com.

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