ARM Mortgage Loans- Pros and Cons
Do Adjustable Rate Mortgage Loans Mean Lower Home Mortgage Payments?
Oct 22, 2009
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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