When is an ARM Better Than a Fixed?
The world of mortgages has a short menu. Will it be an Adjustable Rate Mortgage (ARM) or a Fixed Rate Mortgage? You’ll often hear people say that a fixed-rate mortgage is always the best move
— that’s not necessarily the truth. Homebuyers sometimes have unique circumstances that allow them to take advantage of the initial lower rate of an ARM.
First, let’s distinguish between the two. The interest rate of a fixed-rate mortgage never changes. An adjustable-rate mortgage, on the other hand, resets its interest rate at pre-specified times. For example, a “7/1 ARM” indicates the interest rate is locked in for the first seven years and adjusts annually after year seven. Because rates have been lower in recent times, homeowners generally opt for a 30-year fixed-rate mortgage to lock in that low rate for the life of the loan.
So when might it make more sense to go with an ARM? Here are a few scenarios:
Changing Cities, Changing Jobs. If you think you’ll be moving within a short time frame but prefer not to rent, an ARM is option that could work very well. For example, a student who’s doing a medical residency may wind up practicing in another state after she graduates. Because she’s uncertain where she’ll land after graduation, an ARM may be the better choice for a few years.
Investment Property. If you’re buying an investment property but only plan to hold onto it for a limited period, why not take the lower rate?
Salary Bump. If your budget is stretched now, but you’re confident your salary will increase in the next 5-7 years, you could start with an ARM and then refinance your mortgage before the rate goes up.
First-time Homebuyers. In cases where financing a 30-year fixed is not a viable option, first-time homebuyers may choose an ARM and either sell or refinance later.
While ARMs usually have caps in place for rate increases, there are usually no caps or limits to how much the first adjustment after the reset point will be. If you wind up staying beyond the first interval of your ARM, you could face a larger rate increase than you can afford. This is why we only recommend ARMs for the short term, even though it’s entirely possible the rate could adjust down.
Ready to buy a new home or refinance the one you own? Please get in touch and I’ll be happy to answer your questions and help guide you through the process. I look forward to speaking with you.