Adjustable-Rate Mortgages Are Probably Still a Bad Idea
Home prices are finally starting to come down, but rising interest rates are making monthly mortgage payments more unaffordable than ever before. With all this financial uncertainty, you might want to consider adjustable rate mortgages, which are starting to grow in popularity again . If the term sounds familiar, it’s because it’s the same type of loan that was instrumental in the 2008 housing crash , and you should still avoid it today.
What is an adjustable rate mortgage?
An adjustable rate mortgage (or ARM) starts at a fixed rate of interest, which is lower than a regular fixed rate mortgage for the first (usually) 5-7 years of the loan. However, the interest rate may increase (or decrease) after this initial period expires, depending on the current rate. So while it has the advantage of starting with a lower monthly payment than a fixed rate mortgage, it’s a risky option because the payments on a floating rate mortgage can change over time, sometimes dramatically. Meanwhile, the fixed-rate mortgage will remain the same for the entire loan.
It’s also important to know that your ARM payment may increase even if interest rates fall . This is because adjustable rate mortgages have a limit on how much interest rates can rise during the year. However, it may also have the option to carry this additional hike forward to a future rate adjustment. So while others see rates going down, yours may go up.
Is ARM a good idea?
An adjustable rate mortgage is a bet that either interest rates will go down in the future, allowing them to refinance at a lower monthly payment, or their personal income will rise in the future, allowing them to pay a higher monthly rate if or when the loan rate rises. And even if interest rates fall in the future, the buyer will not be able to refinance because of a low credit score or because the value of his home has fallen below what he still owes for it. (House prices can drop to the point where you owe more than what it’s worth – which is what happened in 2008 when prices dropped by about 20% .)
This may make sense for those who know they plan to sell the house before the flat rate period ends: meaning they will take advantage of the lower rate for a short time and leave before the rate has potentially increased. Of course, it’s important to keep in mind that unforeseen circumstances may prevent you from selling when you want to, so it’s still a risk.