Welcome to Ask the CFP®! In this episode, I’m addressing the question: should I use an Adjustable-Rate Mortgage?
Unlike traditional fixed-rate mortgages, adjustable-rate mortgages – commonly referred to as ARMs – have an interest rate that adjusts over time. These have become more popular recently due to rising interest rates. ARM rates are typically lower than fixed-rate mortgages because they can adjust over time, which can place more risk on the borrower if market rates increase. Fixed rates for 30-year mortgages dipped below 3% in 2021. That’s a bargain compared to today’s rates, which is one reason why ARMs should be considered.
Because ARMs generally have initial rates that are lower than fixed rate mortgages, plus the rate may decrease over time if market rates decrease, they may make sense for certain homebuyers. ARMs typically have a fixed-rate period, followed by an adjustable-rate period. For example, many ARMs are for 30-year terms and may be the 5/1 or 7/1 types of ARMs. This means the rate is fixed for the first five or seven years, at which time the rate can adjust once each year for the remainder of the 30-year period. Most ARMs also have a periodic or lifetime rate cap that limits how high the rate can climb each year or over the lifetime of the loan.
The greatest risk with an ARM is if interest rates rise over time and remain higher for the 30 years you have the loan. However, keep in mind that these loans could potentially be paid off early if you have enough liquid assets. Or you may be able to refinance to a fixed-rate mortgage if rates decline in the years ahead.
We find that people don’t typically hold ARMs for the full 30 years. They’re more commonly used when someone anticipates interest rates decreasing in the years ahead. The Federal Reserve Bank has a goal of maintaining inflation at around 2% per year, so it’s likely that interest rates may decrease. Time will tell if-and-when the Fed Bank can accomplish this goal, so in the meantime, consider the pros and cons of an adjustable-rate mortgage.
As always, your Moneta team is ready to discuss which mortgage options are best for your specific situation.
If you have a question about this topic or have a suggestion for a future Ask the CFP® video, please send it to TFreeman@MonetaGroup.com. Thanks for watching and we’ll see you next month.
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