Is an Adjustable Rate Mortgage Right for You?
If you’re thinking of applying for an adjustable rate mortgage, the following information may help you make an informed decision.
What is an ARM?
Traditional fixed rate mortgages have an interest rate that remains in place throughout the life of the loan, but the interest rate in an adjustable rate mortgage (ARM) can change at certain predetermined points.
Several types of ARMs are available, labeled by their initial interest rate period. For example, a 10/1 ARM has a fixed interest rate for 10 years, and then the rate adjusts once each year after that (1).
When it’s time to adjust, the lender sets the new rate by looking at an index like LIBOR or some other acceptable standard. The lender takes that index and adds a margin, which stays the same during the life of the mortgage. For example, if the index is 3 percent and the margin is 2 percent, the rate will adjust to 5 percent. At the next adjustment, if the index is 2.5 percent, the margin is still 2 percent, so the loan rate will be set at 4.5 percent.
In order to help protect borrowers against extremely high interest rates, most ARMs will also include an interest rate cap limiting how high the rate can be or how much the interest rate can change from one year to the next.
One of the main advantages of an ARM is that the initial interest rate is usually lower than that of a fixed rate mortgage, making it easier for the borrower to qualify for the loan and to afford the monthly payments. Another advantage is that, if interest rates fall, the borrower can enjoy lower interest rates and lower payments without the need to refinance the mortgage.
James McWhinney of Investopedia1 suggests asking yourself these questions:
- How large a mortgage payment can you afford today?
- Could you still afford an ARM if interest rates rise?
- How long do you intend to live on the property?
- In what direction are interest rates heading, and do you anticipate that trend to continue?
The best advice for anyone trying to decide between mortgage options is to consult a professional with a good track record. Ask for referrals from friends and family and check out online reviews. Then, enjoy your home, knowing you did your best to finance it responsibly.
To find out more about Nevada State Bank’s mortgage loans, or for specific down payment information, contact a mortgage loan officer.
The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice. Any views expressed in this article may not necessarily be those of Nevada State Bank, a division of Zions Bancorporation, N.A. Member FDIC