How to know if the popular adjustable-rate mortgage is right for you

On Apr 29, 2022

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Adjustable-rate mortgages are making a comeback.

With interest rates surging, more buyers are turning to ARMs, which offer lower initial rates than fixed-rate loans. However, after a certain period, the rate on the ARM adjusts to reflect current market conditions.

“You have double the number of borrowers out there applying for ARMs in the last four months because of how quickly the rates have come up,” said Joel Kan, associate vice president of economic and industry forecasting at the Mortgage Bankers Association.

The rate for a 30-year fixed rate mortgage is 5.41%, according to Mortgage News Daily. Meanwhile, the rate for a 5/1 ARM is 4.38%. The “”5” means the rate is fixed for five years and the “1” means it would then readjust once every year for the remaining life of the loan.

“Clearly people are looking for other options when it comes to financing their home, because they are competing with other borrowers and they are likely looking to secure the home that they want, given how tight housing inventory is,” Kan said.

How ARMs work

There are different timeframes available for the fixed part of the loan: generally three, five, seven and 10 years. The readjustment period could be one year or six months, which would look like 7/1 or 7/6, respectively, for a seven-year ARM.

There are also caps on the interest rate, meaning there is a maximum amount the rate can increase or decrease each time, as well as a lifetime maximum cap. For instance, if you have a 5% lifetime cap on your 5/1 ARM, your 4.38% rate could eventually wind up at 9.38%.

Be sure you know how much higher the interest on your loan can go and what that means for your monthly payment and its impact on your budget.

Danielle Hale

Chief economist at Realtor.com

That’s why it is so important to understand the specific terms of the loans you are considering.

“Using an adjustable-rate mortgage can make sense in some situations, but it’s a more sophisticated mortgage product,” said Danielle Hale, chief economist at Realtor.com.

“Buyers considering it will want to make sure they understand the pros, cons and risks.”

Weighing your options

ARMs aren’t nearly as popular as they were during the subprime mortgage crisis in mid-2000s, when credit standards were lax and a lot of borrowers ended up in trouble. These days, the credit standards are a lot higher and underwriting is extremely tight, Kan said.

“We are not looking at the same kind of risks as we did then,” he said.

That said, if you take out an adjustable-rate mortgage, you risk ultimately ending up with an interest rate that is substantially higher than a fixed-rate loan.

Therefore, if you are considering an ARM, think about how long you plan to stay in the home.

“It might make sense for people who are looking at a…