29 Jan

What is an Adjustable-Rate Mortgage?

General

Posted by: Randell Toporowski

What is an Adjustable Rate Mortgage and How Can it Help You?

Adjustable Rate Mortgages (ARMs) are an increasingly popular option for homeowners looking to buy a home or refinance their existing mortgage. With an ARM, the interest rate on your loan can change over time. This can be a great option for homeowners who want to take advantage of a lower rate, but it also carries some risks. In this article, we’ll examine what an adjustable rate mortgage is, how it works, and what advantages and disadvantages it offers. We’ll also look at when an adjustable-rate mortgage might be the right choice for you, how to choose the right one, and how to calculate your adjustable-rate mortgage payments. Finally, we’ll discuss some common adjustable-rate mortgage terms and offer some tips for managing an adjustable-rate mortgage.

Introduction to Adjustable Rate Mortgages

An adjustable-rate mortgage (ARM) is a type of mortgage loan that has an interest rate that can change over time. ARMs typically start with a fixed rate period, during which the interest rate will stay the same. After this period, the interest rate can increase or decrease depending on the terms of the loan. ARMs are popular because they generally offer lower rates than other loan types. However, they also carry some risks, such as the potential for higher payments in the future.

How an Adjustable Rate Mortgage Works

An adjustable-rate mortgage works similarly to other mortgage loans. You apply for the loan and provide documentation of your income, credit, and other financial information to your mortgage broker. Once approved, you will make monthly payments to pay off the loan. Those payments are applied to your principal and the interest portion of your regular monthly mortgage payment.

The difference with an ARM is that the interest rate can change over time, and your interest portion of the mortgage payment will change as the prime lending rate changes. If the prime lending rate moves upward, so will the interest portion of your mortgage payment; and your payment will increase. Likewise, if the prime lending rate moves downward, so will the interest portion of your mortgage payment; and your payment will decrease. In a true adjustable-rate mortgage the principal portion of your mortgage payment remains the same, paying off the mortgage principal on your original loan amortization schedule.

Generally, the initial rate is lower than what you would get with a fixed-rate mortgage.

Advantages of Adjustable Rate Mortgages

The main advantage of an adjustable-rate mortgage is the lower interest rate. Since the rate is based on market conditions, you can get a lower rate than you would with a fixed-rate mortgage. This can save you money on your monthly payments and help you pay off your loan faster.

As mentioned, another advantage of an ARM is that you can take advantage of lower rates if the prime lending rate drops. If the prime rate goes down, so does your interest rate, meaning you can save even more money on your monthly payments.

Disadvantages of Adjustable Rate Mortgages

The main disadvantage of an adjustable-rate mortgage is the potential for higher payments in the future. Since the rate can change over time, your payments can increase if the prime rate rises. This could make it difficult to afford your monthly payments if the rate goes up too much.

Another disadvantage is that you may have to pay a fee if you want to change the terms of the loan. For example, you may have to pay a fee if you want to switch from an ARM to a fixed-rate mortgage.

When an Adjustable Rate Mortgage Might Be the Right Choice

An adjustable-rate mortgage might be the right choice if you are looking for a lower interest rate and don’t mind the potential risks. ARMs can be a good option if you plan to stay in your home for a few years and don’t plan to refinance soon.

ARMs can also be a good option if you are comfortable with the potential risks. You should be prepared for the possibility of higher payments in the future and make sure you can afford the potential increase in payments.

How to Choose the Right Adjustable Rate Mortgage

When choosing an ARM, it’s important to compare different lenders and loan products. Look at the initial rate, the term of the loan, and the prime lending rate the loan is tied to. You should also look at the fees associated with the loan, such as any fees for switching from an ARM to a fixed-rate mortgage.

It’s also important to read the fine print. Make sure you understand all the terms and conditions of the loan and know what to expect if the prime lending rate goes up or down.

Tips for Managing an Adjustable Rate Mortgage

When you have an adjustable-rate mortgage, it’s important to stay informed and manage your loan wisely. Here are some tips for managing an ARM:

  • Monitor the Prime Lending Rates to get an idea of what to expect.
  • Make sure to keep up with your payments, as missed payments can have a negative impact on your credit score.
  • Consider refinancing to a fixed-rate mortgage when the adjustment period is up.
  • Consider setting up an escrow account to make sure your taxes and insurance are paid on time.
  • Consider setting up automatic payments to make sure your payments are made on time.

Conclusion

An adjustable-rate mortgage can be a great option for homeowners who want to take advantage of a lower interest rate. However, it’s important to understand the risks and be prepared for the possibility of higher payments in the future. Make sure to compare different lenders and loan products, read the fine print, and get a rate lock. With the right loan and management strategy, an ARM can be a great option for saving money and paying off your loan faster.

If you have any questions on an adjustable-rate mortgage, do not hesitate to contact me.  Randell is a Mortgage Broker with DLC BlueTree West Powerhouse Mortgages in Regina, SK.  He can be contacted at 306-541-5438 or at randellt@dominionlending.ca