Guest post by Amanda Burke.
Should I consider an adjustable rate mortgage (ARM)? That’s a really good question.
When considering a mortgage, you will find that there are a variety of loan options out there. One of those options may include an adjustable rate mortgage. An adjustable rate mortgage is a mortgage in which a borrower’s interest rate fluctuates according to an index of interest rates based on the rising and falling of credit in the economy—thus transferring interest rate risk to the borrower.
There are hidden dangers with this type of mortgage that can cause severe financial implications later on, and it is important to consider those dangers before agreeing to the mortgage.
1. Your interest rate could go up. There is usually an incredibly low introductory rate offered, for example, 2%, and they rate-adjust to the market over a period of time, typically 3-5 years. The problem is that we cannot predict what the market rate will be in 3-5 years, and the person becomes locked into a much higher rate than they could have gotten with a different lending option.
ARMs do have an interest rate cap, which limits the amount that an interest rate can increase. For example, the interest rate can increase to more than 2% per year and no more than 6% over the life of the loan. However, this would be triple the original interest rate, and over time, this greatly compounds the amount that you end up paying.
2. You will pay fees to refinance in the future. Borrowers typically jump into an adjustable rate mortgage because the introductory rate sounds great, and they decide that it will be convenient to refinance their loan in 3-5 years. This does not come without cost, though, because in doing so they, will incur additional fees to their loans. Not to mention that in 3-5 years the market will change, and we never know what future life circumstances will be.
For example, the borrower could be facing a financial hardship, or the property could lose its value. Both scenarios prevent him or her from qualifying for a refinance, and the borrower is now stuck with a higher interest rate. If the hardship is bad enough, and the homeowner falls behind on payments, the lender may even foreclose on the home.
3. A future rate increase will impact your future budget. Historically, payments are a little bit lower in the beginning due to the lower interest rate; once the interest rate goes up, the payment increases. If you are budgeting, then you should consider the implications of a higher payment in your future, and how it will affect your budget later on.
Be wary of ARMs. Look at all options, including fixed rate mortgages. Do not be fooled by the teaser rates, and make a wise decision when reviewing those options.
This is a guest post by Amanda Burke, the co-founder of Camp Change Ministries and Accredited Financial Counselor® (AFC®) with more than 15 years of experience in the financial industry. She is also currently pursuing the CFP® (Certified Financial Planner) designation. As a result of her background, Amanda is passionate about apologetics and financial literacy, and enjoys serving within the church and community teaching these skills to both adults and children. Amanda is also a wife and home school mom to three children, Hannah, Harper and Zebulon.