It pays to understand the pros and cons of adjustable rate mortgages: Here's a quick study:
Adjustable Rate Mortgages
(Also called variable-rate loans) offer the benefits of a lower initial interest rate as compared to fixed-rate loans. The interest rate will go up and down over the life of the loan based on market conditions. However, the loan agreement will usually set maximum and minimum rates that will apply. If interest rates increase, so will your loan payments. Conversely, when interest rates go down, your payments are lower.
The advantages of Adjustable Rate Mortgages are:
- You may be able to qualify for higher loan amounts
- You start out with lower monthly payments.
- You pay less for owning a home for a short period of time
The disadvantages of Adjustable Rate Mortgages are:
- Rising interest rates could increase payments sharply
- You can't predict with certainty what your housing costs will be.
- There is more risk, especially if you remain in your home for a long period of time.
- Lower initial interest rates mean it will typically take longer to pay off principal in your home and build up additional equity beyond that which may occur with market appreciation.
The Bottom Line: The lower initial interest rates of Adjustable Rate Mortgages (ARMs) may allow borrowers to qualify for a home/or "more home" at higher loan amounts than they normally would. Lower initial interest rates will typically allow borrowers to pay less for their home over the short term and provide them with the potential to build up market equity. If interest rates should rise sharply however, ARMs can put a considerable amount of financial pressure on borrowers. Most lenders count on the fact that younger-middle aged homeowners with rising incomes can handle higher payments that may result.