Adjustable-Rate Mortgages are gaining popularity — but are they right for you?

Adjustable-Rate Mortgages Are Gaining Popularity: Is an ARM Worth Considering?

With mortgage rates continuing to impact affordability, homebuyers are looking at more than just the traditional 30-year fixed-rate mortgage.

One option getting renewed attention is the Adjustable-Rate Mortgage, commonly called an ARM.

ARMs aren't new, but they can become more attractive when there is a meaningful difference between the introductory rate on an ARM and the rate available on a fixed-rate mortgage.

So, should today's homebuyers consider one?

Maybe — but an ARM is definitely a mortgage you want to understand before signing on the dotted line.

What Is an Adjustable-Rate Mortgage?

An Adjustable-Rate Mortgage (ARM) is a mortgage with an interest rate that is typically fixed for an initial period and then adjusts periodically.

For example:

5/1 ARM: The interest rate is fixed for the first 5 years and can then adjust once each year.

7/1 ARM: The interest rate is fixed for the first 7 years and can then adjust once each year.

Other ARM structures are available, and some newer ARMs adjust every six months after the introductory period.

The important thing to understand is that the first number generally tells you how long the initial fixed-rate period lasts, while the second part describes how frequently the rate can adjust afterward.

According to Freddie Mac, ARM initial fixed periods can vary, and borrowers need to understand both the initial period and the adjustment period before selecting a loan.

1. Why Would Someone Choose an ARM?

The biggest attraction is usually the introductory interest rate.

ARMs often begin with a lower interest rate than comparable fixed-rate mortgages.

That can mean a lower initial monthly principal-and-interest payment and potentially give a buyer additional flexibility during the first several years of homeownership.

But there's a tradeoff:

That initial rate doesn't necessarily last forever.

Once the introductory period expires, the interest rate can increase or decrease based on the terms of the mortgage and market conditions.

According to the Consumer Financial Protection Bureau, an ARM's adjusted interest rate is generally determined using an index plus a margin, subject to the caps contained in the loan.

That is why buyers shouldn't compare mortgages based solely on the introductory rate.

Important: Property taxes, homeowners insurance, HOA fees and similar housing expenses can still change even when you have a fixed-rate mortgage.

The Potential Advantages of an ARM 1. A Lower Initial Interest Rate

One of the primary reasons buyers consider an ARM is the possibility of securing an introductory rate below the rate offered on a comparable fixed-rate mortgage.

A lower rate can translate into a lower initial principal-and-interest payment.

2. It May Fit a Shorter Ownership Timeline

Suppose you're purchasing a home but reasonably expect to relocate within five years.

A 7-year ARM, for example, could potentially allow you to sell the property while you're still within the initial fixed-rate period.

However, this should never be your only protection against a future payment increase.

Life changes.

Markets change.

Plans change.

You need to be comfortable with what happens if you still own the property when the rate begins adjusting.

3. Your Rate Could Potentially Decrease

An adjustable rate doesn't automatically mean the rate goes up.

Depending on the mortgage terms and what happens with the loan's underlying index, your interest rate could decrease when it adjusts.

However, some ARMs include provisions that limit how much the rate can decrease.

4. Rate Caps Provide Some Protection

Most ARMs contain rate caps designed to limit how much the interest rate can change.

There are typically three types:

Initial Adjustment Cap
Limits how much your interest rate can change the first time it adjusts.

Subsequent Adjustment Cap
Limits how much the rate can change during later adjustment periods.

Lifetime Cap
Limits how much the interest rate can change over the life of the mortgage.

These caps are extremely important.

Two ARMs offering the exact same introductory rate can have very different risk profiles because their adjustment terms and caps are different.

5. Refinancing May Be an Option Later

Some homeowners choose an ARM with the expectation that they may refinance into a fixed-rate mortgage later if interest rates decline.

That's certainly possible.

But here's the important part:

Refinancing is never guaranteed.

Your income, employment, credit, debt-to-income ratio, property value and future mortgage rates can all affect your ability to refinance.

What Are the Risks of an ARM?

There is no getting around the biggest one:

Your payment could increase.

When the introductory fixed-rate period expires, your rate can adjust.

If the applicable index is higher, your new rate — and therefore your monthly principal-and-interest payment — may be higher.

The CFPB specifically cautions consumers against assuming they'll automatically be able to sell or refinance before their ARM adjusts.

Your financial situation could change.

The property's value could decline.

Mortgage qualification requirements could change.

Or interest rates simply may not move in the direction you expected.

That's why I wouldn't recommend looking at an ARM based only on what the payment is today.

You also need to know what the payment could become.

5 QUESTIONS TO ASK YOUR LENDER BEFORE CHOOSING AN ARM

1. How long is my interest rate fixed?

Is this a 3-year, 5-year, 7-year or 10-year initial fixed period?

Know exactly when the first adjustment can occur.

2. How often can my rate change after that?

Don't assume.

Depending on the ARM, adjustments could occur annually, every six months or according to another schedule specified in the loan.

3. What are my rate caps?

Ask for all three:

Initial Adjustment Cap, Subsequent Adjustment Cap, Lifetime Cap

Then ask your lender to show you exactly what those caps mean using your actual loan amount.

4. What is the index and margin?

After the introductory period, an ARM's interest rate is generally determined by:

INDEX + MARGIN = ADJUSTED INTEREST RATE

subject to the loan's applicable caps.

The index fluctuates based on market conditions.

The margin is established by the lender and is generally set in your loan agreement.

You need to understand both.

5. What's the highest my payment could become?

This may be the most important question of all.

Don't just ask:

"What's my payment today?"

Ask:

"What is the maximum interest rate allowed under this loan, and what would my principal-and-interest payment be at that rate?"

Then decide whether that payment would still be manageable.

Don't Choose a Mortgage Based on the Rate Alone

When comparing an ARM to a fixed-rate mortgage, ask your lender to prepare a side-by-side comparison.

Look at:

• Interest rate

• APR

• Monthly principal & interest payment

• Loan term

• Closing costs

• Initial fixed-rate period

• Adjustment schedule

• Index

• Margin

• Adjustment caps

• Lifetime maximum rate

• Maximum potential payment

Then look beyond the numbers.

Think about your actual plans.

Ask Yourself:

How long do I realistically expect to own this home?

Is there a reasonable possibility I'll still own it when the rate starts adjusting?

Could I afford the payment if the rate increases?

Am I comfortable with some uncertainty in exchange for a potentially lower introductory rate?

Am I choosing this mortgage because it fits my financial strategy — or simply because the initial payment allows me to buy a more expensive house?

That last question is important.

A lower introductory payment shouldn't be used to convince yourself that you can comfortably afford a home that would otherwise stretch your budget.

So, Who Might Consider an ARM?

An ARM may be worth discussing with your mortgage professional if you:

✓ Expect to own the property for less time than the ARM's initial fixed period.

✓ Want to evaluate the potential savings offered by a lower introductory rate.

✓ Have sufficient room in your budget to absorb a potential payment increase.

✓ Understand the loan's index, margin, adjustment schedule and caps.

✓ Have compared the ARM directly with available fixed-rate financing.

On the other hand, someone planning to stay in the same home for many years may place greater value on the predictability of a fixed-rate mortgage.

There isn't one mortgage that's automatically best for every buyer.

The right financing should fit the buyer — not the other way around.

One More Thing: Don't Count on Refinancing

I hear this strategy frequently:

"I'll take the lower rate now and just refinance when rates come down."

That may work.

But I wouldn't make a major home-buying decision based on the assumption that it definitely will.

The Consumer Financial Protection Bureau specifically advises ARM borrowers not to assume they'll be able to sell or refinance before their rate changes.

A better strategy is to choose a mortgage you can reasonably manage under its terms — and treat a future refinancing opportunity as a potential benefit rather than a guarantee.

The Bottom Line

Adjustable-rate mortgages aren't inherently good or bad.

They're simply another financing tool.

For the right buyer, with the right loan terms and the right timeline, an ARM may be worth considering — especially when its introductory rate is meaningfully below comparable fixed-rate financing.

For another buyer, the predictability of a fixed-rate mortgage may be far more important.

That's why I believe the best approach is simple:

Understand your options before you make your decision.

Ask your lender to run the numbers.

Compare the loans side-by-side.

Look at today's payment and tomorrow's potential payment.

And make sure your financing fits both your current budget and your longer-term plans.

Ready to Start Your Home Search?

Buying a home involves a lot more than finding a house you love.

Financing, inspections, negotiations, contracts, title work, appraisals and deadlines all have to come together to get you successfully from Start to Sold.

At Locals Realty, my team and I help buyers understand the entire process and work alongside their lender, title company and other professionals from beginning to closing.

Whether you're a first-time buyer, VA buyer, relocating military family, repeat homeowner or investor, we're here to help.

Have questions about buying a home or wondering what homes are available in your price range?

Let's talk.

I'm always here to help — even if you're just starting to explore your options.

Sherri L. McNeely
Broker/Owner | Locals Realty
Your Friend in Real Estate

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SOURCES & ADDITIONAL RESOURCES

Consumer Financial Protection Bureau — Adjustable-Rate Mortgages
The CFPB provides consumer information explaining the differences between fixed-rate and adjustable-rate mortgages, indexes and margins, rate adjustments and ARM caps.

Freddie Mac — Adjustable-Rate Mortgage Resources
Freddie Mac provides educational resources explaining ARM structures, introductory periods, adjustment periods and considerations when comparing fixed- and adjustable-rate mortgages.

This article is provided for general educational and informational purposes only and should not be considered mortgage, financial, tax or legal advice. Mortgage programs, rates, costs, eligibility requirements and loan terms vary by lender, borrower and property. Buyers should consult with a qualified mortgage professional regarding their individual financial situation and available loan programs.