As mortgage rates remain elevated, more homebuyers are taking a closer look at Adjustable-Rate Mortgages (ARMs) as an alternative to traditional fixed-rate mortgages.
An ARM typically offers a lower introductory interest rate for a specified period—often 5, 7, or 10 years. After that initial period, the interest rate can adjust at scheduled intervals based on the terms of the loan.
For some Arizona homebuyers, an adjustable-rate mortgage can provide a way to reduce the initial monthly payment. However, an ARM also introduces additional uncertainty because the payment can increase after the introductory period ends.
What Is an Adjustable-Rate Mortgage?
An Adjustable-Rate Mortgage is a home loan where the interest rate is generally fixed for an initial period and then becomes adjustable.
For example, a 5/1 ARM generally means:
- The initial interest rate is fixed for the first 5 years.
- After the initial 5-year period, the rate can adjust.
- The rate may then change at scheduled intervals according to the loan's terms.
Other common structures include 7/1 ARMs and 10/1 ARMs.
The exact adjustment schedule, index, margin, caps and other loan provisions vary by mortgage product, so borrowers should review the specific terms carefully before choosing an ARM.
Why Are Buyers Considering ARMs?
One of the primary attractions of an ARM is the possibility of a lower initial mortgage rate compared with a comparable fixed-rate loan.
For a buyer who expects to move, sell or otherwise pay off the mortgage before the adjustable period begins, the initial rate can be an important consideration.
For example, someone purchasing a home today who expects to relocate within several years may not expect to hold the mortgage long enough to experience a rate adjustment.
However, that strategy should not be based solely on the assumption that the home will be sold or refinanced. Life circumstances and real estate markets can change.
The Pros of an Adjustable-Rate Mortgage
1. Potentially Lower Introductory Rate
An ARM may offer a lower initial interest rate than a comparable fixed-rate mortgage.
That can result in a lower initial monthly principal-and-interest payment, although borrowers should compare the complete loan terms rather than focusing only on the initial rate.
2. Potential Savings During the Introductory Period
If the ARM's initial rate is lower than the available fixed-rate alternatives, the borrower may have lower mortgage payments during the introductory period.
The actual savings depend on the loan amount, interest rate, fees and other terms.
3. Rate Caps Can Limit Adjustments
Many ARMs have interest-rate caps that limit how much the interest rate can increase at each adjustment and/or over the life of the loan.
Caps are an important part of evaluating an ARM because they can help borrowers understand the maximum potential rate changes allowed under the loan terms.
4. May Make Sense for a Shorter-Term Homeowner
An ARM may be worth considering for a borrower who has a reasonable expectation of selling the property before the introductory period ends.
For example, a buyer who expects to move within five years might compare a 5-year ARM with a 30-year fixed-rate mortgage.
Still, the decision should account for the possibility that the buyer ultimately remains in the property longer than expected.
5. Potential to Refinance
Another possibility is refinancing into a fixed-rate mortgage before or after the ARM begins adjusting.
If mortgage rates become more favorable, refinancing could potentially provide a different loan structure.
However, refinancing is never guaranteed. The borrower's credit, income, debt, home value, available loan programs and prevailing interest rates can all affect whether refinancing is possible and financially worthwhile.
The Cons of an Adjustable-Rate Mortgage
1. Your Payment Could Increase
The biggest consideration with an ARM is what happens after the introductory period.
If the loan's interest rate adjusts upward, the borrower's monthly principal-and-interest payment can increase.
Homebuyers should determine what their payment could look like under different rate scenarios before choosing an ARM.
2. Future Interest Rates Are Unknown
No one can know with certainty where mortgage rates will be several years from now.
An ARM can benefit a borrower if rates decline or remain favorable, but rising rates can increase the cost of carrying the mortgage.
3. Refinancing Is Not Guaranteed
Some borrowers assume they can simply refinance before an ARM adjusts.
That may not always be possible.
A borrower could experience a lower credit score, higher debt-to-income ratio, reduced income or a decline in the property's value. Any of these factors could affect the ability to qualify for a future refinance.
4. Prepayment Provisions Need to Be Reviewed
Borrowers should determine whether their particular ARM includes any prepayment penalty or other restrictions.
Loan terms vary, so buyers should review the specific disclosures and ask their mortgage professional about any potential costs associated with paying off or refinancing the loan early.
ARM vs. Fixed-Rate Mortgage
The primary difference is how the interest rate behaves over time.
Feature Adjustable-Rate Mortgage Fixed-Rate Mortgage Initial rate May be lower Generally higher than an ARM's introductory rate Initial payment May be lower More predictable Future rate Can adjust Remains fixed Payment risk Can increase More predictable Long-term certainty Lower Higher Potential refinancing Possible Possible
Neither loan structure is automatically right for every buyer. The appropriate comparison depends on the buyer's finances, expected time in the property, loan terms and tolerance for future payment changes.
Questions Arizona Homebuyers Should Ask Before Choosing an ARM
Before selecting an adjustable-rate mortgage, consider asking:
What is the initial interest rate?
How long is the introductory period?
When can the first adjustment occur?
How often can the rate adjust after that?
What index and margin determine the new rate?
What are the interest-rate caps?
What is the maximum possible payment?
Are there any prepayment penalties?
What would happen if I still own the home when the introductory period ends?
Could I afford the payment if the rate reaches the maximum permitted level?
These questions can help buyers evaluate the loan based on its full structure rather than simply comparing the initial advertised interest rate.
Don't Base an ARM Decision on One Assumption
One of the biggest mistakes a borrower can make is assuming that they will definitely sell or refinance before the ARM adjusts.
That may happen—but circumstances can change.
A buyer could decide to stay in the home longer. A job relocation could disappear. Home prices could decline. Mortgage rates could remain high. Lending requirements could change.
An ARM should therefore be evaluated based on what happens if the borrower keeps the mortgage beyond the initial fixed-rate period, not just what happens if everything goes according to plan.
Bottom Line for Arizona Homebuyers
Adjustable-Rate Mortgages are an important option for today's homebuyers, particularly when the initial ARM rate is meaningfully below comparable fixed-rate mortgage options.
The potential benefit is a lower introductory payment. The tradeoff is that the interest rate—and potentially the monthly payment—can change later.
For buyers considering an ARM, the key is understanding the entire loan structure, including the introductory period, adjustment schedule, caps, margin, index, potential payment changes and any prepayment provisions.
Before choosing between an ARM and a fixed-rate mortgage, compare the actual loan estimates and consider how the payment would fit into your budget both today and after the introductory period ends.
Looking to Buy or Sell an Arizona Home?
Mountain Lake Realty provides Arizona real estate services with a focus on flat-fee real estate options for Arizona homeowners and buyers.
If you're considering buying a home in Phoenix, Scottsdale, Mesa, Gilbert, Chandler, Prescott, Surprise, Peoria or elsewhere in Arizona, understanding your financing options is an important part of the real estate process.
Mountain Lake Realty
602-888-7073
Arizona Flat-Fee Real Estate
https://arizonamlsflatfee.com/
Mortgage rates, loan programs and lending requirements change over time. This article is for general informational purposes and is not mortgage, financial or legal advice. Consult a qualified mortgage professional regarding the specific terms and suitability of any loan.
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