Is It Always a Good Idea to Choose an Adjustable Rate Mortgage?
Potential homeowners face an important decision when choosing between a fixed-rate mortgage (FRM) and an adjustable-rate mortgage (ARM). Although ARMs have had a mixed reputation since the 2008 housing crisis, financial experts suggest there are specific scenarios in which they may be the right choice for certain borrowers. Here’s what you need to know about how adjustable rate mortgages work and when they might be right for you.
When an Adjustable Rate Mortgage May Make Sense
The main appeal of ARMs is their lower initial interest rates compared to fixed-rate mortgages. These introductory rates typically last between three and 10 years, offering significant savings in the early years of home ownership. Chad Gammon, CFP and owner of Custom Fit Financial , explains that this lower initial rate can be especially beneficial for homeowners who expect either income to rise or interest rates to fall over the life of the loan.
However, Gammon emphasizes the importance of understanding the risks: “Once the introductory interest rate period ends, the rate may adjust upward.” A good example is ARM processors, which were discontinued before 2020. He emphasizes that ARMs are more complex financial instruments, so it is critical for borrowers to fully understand the consequences of going beyond the fixed rate period.
Short-term home ownership
For those who don’t plan to put down long-term roots, ARMs can offer significant benefits. Doug Carey, CFA and founder of WealthTrace , notes that many homeowners have lived in their properties for less than seven years. “If the plan is to sell the house before the rate adjusts,” Carey explains, “a lower initial rate will benefit them financially.” This strategy allows homeowners to benefit from lower rates during their planned stay while avoiding potential rate increases in the future.
Availability in high cost markets
In high-priced housing markets, ARMs can make homeownership more affordable. Lower down payments can help buyers qualify for homes that would otherwise be unaffordable with a traditional fixed-rate mortgage. While this approach carries the risk of rates adjusting in the future, it can be a calculated risk for those expecting income growth or planning to refinance later.
Strategic Refinancing Opportunities
Many ARM borrowers plan to refinance before the adjustable period begins. Carey highlights this as a potential money-saving strategy: “Take advantage of low rates during the initial period, then refinance at an opportune time to either lock in a lower fixed rate or continue with another ARM.” This approach requires careful timing and market awareness, but can result in significant long-term savings.
How to Decide If ARM Is Right for You
Andre Small, founder and financial planner at A Small Investment, LLC , shares a practical example of when an ARM makes sense. He describes working with a client whose career required frequent relocation, but who still wanted to build wealth in real estate. In this case, the ARM provided the ability to “pay off debts now while also maintaining a manageable level of debt over a predetermined period of time.”
When considering an ARM, potential borrowers should evaluate several factors:
-
Expected tenure
-
Career growth and potential income growth
-
Current Market Conditions and Rate Trends
-
Personal risk tolerance
-
Long-term financial goals
While ARMs can offer significant benefits in certain circumstances, they require careful consideration of the risks and a clear understanding of the terms of the loan.
Bottom line
Adjustable rate mortgages may be a viable option for some borrowers, but the key to success is having a clear exit strategy. If you can take advantage of lower rates to increase your principal payments, an ARM may be a smart move. But if you need an ARM to afford a home, you’re taking on significant risk. As with any major financial decision, before deciding on an ARM, it is critical to consult with financial professionals who can evaluate your specific situation.