Pros and Cons of Adjustable Rate Mortgage Loans

To fix or to ARM are the primary choices which borrowers face when selecting the mortgage loan to suit individual requirements. Adjustable rate loans are known as ARMs in America and variable in the U.K. It is important that borrowers understand both the pros and cons of adjustable rate loans and thus make an informed decision if this type of loan is appropriate, or whether a fixed rate would better suit their needs.

Adjustable rate mortgages are linked to the lender’s mortgage interest rate, which can fluctuate as interest rates shift. Most loans have an annual and lifetime cap on the interest rate which can be levied, which allows borrowers to consider the worst-case scenario if interest rates rise. It is important that borrowers realise that refinancing to lower rates is no longer the easy option it once was, as lenders have tightened their criteria.

The Federal Reserve is introducing a requirement that lenders must make the implications of rising interest rates clear to borrowers, as commissioned research showed that the majority of those with adjustable rate loans were not aware that their payments could increase when interest rates increased. Applicants should make use of online mortgage calculators to ascertain just how an interest rate rise would affect monthly payments.

Naturally, interest rates can go down as well as up, which is good news for those with ARMs, and can save money on potential refinancing to chase better rates. It helps to be aware of predicted interest rate trends when considering an ARM. If they are predicted to fall, this can make them an excellent choice.

The main drawback of ARMs is the uncertainty they carry, making it difficult for borrowers to accurately assess their monthly budgets. Those who enter into such loans unprepared for subsequent interest rate rises can find themselves struggling to keep pace with their monthly payments and unable to afford the payments. However this can be avoided by advance calculation of possible interest rate rises and how they would affect the monthly payment.

Most usually, adjustable rate loans have an initial fixed rate period, which is lower than fixed rate mortgages which come with penalties. Initial payments and interest rates can be lower than those available on fixed rate loans. Anyone considering a home move within five years of signing the mortgage loan will benefit from an adjustable rate, and they are ideal for those who intend to relocate or move home. There will be no imposed penalty fees to consider if a move is made.

It can be a weighty decision for borrowers to determine if an adjustable rate loan fits their requirements. Taking the time to calculate the worst-case scenario of interest rate rises and understanding the caps which the lender sets allows borrowers to make informed decisions as they consider both the pros and cons of adjustable rate loans.

Source: Federal Reserve