What Are the Pros and Cons of an Adjustable Rate Mortgage?
Adjustable rate mortgages got a really bad reputation during the Great Recession, but now they’re back in a big way. In fact, they’re more popular than they’ve been in 15 years.
Hordes of homeowners began defaulting on their adjustable rate mortgages back in 2008, contributing to a massive housing crash. ARMs have since become more heavily regulated and are less likely to break the economy into a million pieces.
Today’s homebuyers are increasingly choosing ARMs to save money as mortgage rates keep rising higher, making monthly mortgage payments painfully expensive. And the Federal Reserve has indicated it’s still concerned about inflation, which likely means additional interest rate hikes are coming.
But is an adjustable rate mortgage the right move for you? We asked a bunch of financial experts and mortgage brokers for their honest opinions, and what they had to say was eye-opening.
What Are the Pros and Cons of an Adjustable Rate Mortgage?
With a fixed rate mortgage, you’ll pay the same interest rate on your mortgage for the entire length of your home loan, most commonly 15, 20 or 30 years. Not so with an adjustable rate mortgage. ARMs start out with a lower, more affordable interest rate for a set period, like 5 to 10 years. After that, they “adjust” to a variable interest rate, based on whatever the market rate is at the time.
Let’s look a little closer at the pros and cons of an adjustable rate mortgage.
Adjustable Rate Mortgages Are Riskier
Interest rates on ARMs can go way up after the initial low-interest period, making your monthly payment a lot harder, if not impossible, to afford. That’s what happened to a lot of people in the last big housing crash.
It’s a risk that more people are willing to take these days, though, because inflation and the Federal Reserve’s rate hikes have jacked up mortgage rates to the highest they’ve been since 2008.
Picture an adjustable rate mortgage where the interest rate is set for the first five years. The average rate on that kind of loan is now more than a full percentage point below that of a 30-year fixed loan, according to Freddie Mac. On a $400,000 loan, that’s about $360 in monthly savings.
How tempting is that immediate savings? Well, the share of mortgage applications that are for ARMs has rocketed up to more than 12%, double what it was in January, according to Zillow. It’s the first time it’s above 12% since 2007. For most of last year, it was only around 2.5%.
How ARMs Have Changed Since the Great Recession
The financial advisors we spoke with are quick to say that today’s adjustable rate mortgages aren’t the same ARMs that cratered the housing market back in 2008.
Back then, many lenders weren’t bothering to check whether homebuyers had enough income to afford a mortgage. When their monthly payments ballooned quickly, those homeowners defaulted on their loans. Since then, stricter regulations have tightened up lending practices.
“In the past, ARMs have been associated with poor mortgage practices, but it’s important to know that ARMs are very different from what they were decades ago and have more regulations in place,” said Heather Harmon, head of finance for Opendoor.
Adjustable Rate Mortgages Could Make Sense if You’re Not Planning to Stay
Here’s the million dollar question: If you’re struggling to afford a house, should you get an adjustable rate mortgage?
We spoke with a lot of financial advisors, and they would all ask you the exact same question:
How long are you planning to stay in that house?
“Adjustable rate mortgages can be good for people who don’t plan on staying in their property long,” said Nate Johnson, a real estate investment expert for NeighborWho, a property search site. “ARMs are almost always guaranteed to be worse deals financially for homebuyers who intend to live in their property for 10 or more years.”
Most ARMs have their interest rates fixed for five, seven or 10 years. After that period, the rate can adjust every six months, according to Matt Hackett, operations manager of Equity Now, a mortgage lender in Mamaroneck, N.Y.
When deciding on a loan, you really need to ask yourself how long you’re likely to stay in one spot.
“My advice to people considering an ARM is to fast-forward their lives,” said Matt Gray, founder of the AnthroFi Wealth Group in Denver. “Are they planning to stay in the house for longer than the fixed-rate period of the loan? If so, what are they going to do if the rate jumps up 3% and they end up owing significantly more per month?”
These Experts Say, ‘Don’t Do It’
Not everyone thinks ARMs are a good idea. We found some experts who said they’d warn you away from them.
Jeffrey Zhou, CEO of Fig Loans, thinks ARMs are too risky because interest rates are probably going to keep going up for some time.
Between inflation driving prices up and the war in Ukraine that’s disrupting oil and gas supplies, the rising costs will likely result in higher interest rates for ARMs in the coming years, he said.
“Thus, getting an ARM doesn’t make sense at all,” Zhou said. “I discourage it.”
Rob Drury, executive director of the Association of Christian Financial Advisors, is suspicious that lenders are so readily offering ARMs these days. In his view, a bank that sells you an adjustable rate mortgage is betting that interest rates are going to rise and make your payments balloon.
“I would never recommend an ARM,” Drury said. “The only time the industry pushes ARMs is when interest rates are low, and in the 15 to 40 years before one’s mortgage is paid off, those rates will inevitably increase, possibly quite significantly.”
These Experts Say, ‘Do It But Be Careful’
Other financial advisors say it can be worth considering an adjustable rate mortgage, as long as you’re careful and you have a contingency plan if mortgage interest rates continue to rise over the life of the loan.
ARMs can be especially useful for people who are in the military who tend to move a lot, said Mike Hunsberger, owner of Next Mission Financial Planning, based in Missouri.
“I work with military personnel who move frequently, so if the buyer knows they will only be in the location for a few years, using an ARM could make sense,” he said.
If you end up going this route, it’s important to decide exactly how long your mortgage’s interest rate will stay the same before it’s allowed to change.
How long will the rate be fixed? The shorter the time, the cheaper the loan is. But if you decide to stay in your house, be prepared to pay more in the long run.
Mike Brassfield ([email protected]) is a senior writer at Codetic.