If you're looking to buy a new home, there are several factors to consider. With changing interest rates, different loan structures, and market availability, it’s easy to get overwhelmed. ProFed Credit Union offers a variety of mortgage loan options to guide you on your path to homeownership.
One mortgage option at ProFed Credit Union is our adjustable-rate mortgages, or ARM loans. These loans provide various options for members currently looking to purchase or refinance a home.
ARM loans can offer flexibility for borrowers who anticipate changes in their financial situation or plan to sell or refinance their property within the initial fixed-rate period. With any adjustable-rate product, there is a level of risk. It's essential for borrowers to carefully consider their financial goals and risk tolerance when deciding whether an ARM loan is the right choice for their home financing needs.
What is an Adjustable-Rate Mortgage (ARM) Loan?
An adjustable-rate mortgage (ARM) loan is a type of variable mortgage in which the interest rate fluctuates periodically based on changes in a specified financial index. ARM loans typically offer a fixed interest rate for a predetermined period, ranging from five to ten years, providing borrowers with lower initial payments than fixed-rate mortgages. At the end of the predetermined period, the interest will adjust based on the financial index.
Types of Adjustable-Rate Mortgage (ARM) Loans?
Different ARM loan types have advantages and considerations, and borrowers should carefully evaluate their financial goals, risk tolerance, and plans when choosing the most suitable option. Working with a knowledgeable lender can help borrowers navigate the complexities of ARM loans and make informed decisions.
- Hybrid ARMs: Hybrid ARMs combine elements of both fixed-rate and adjustable-rate mortgages. They typically start with an initial fixed-rate period, during which the interest rate remains constant for a set number of years, such as 3, 5, 7, or 10 years. After the initial fixed-rate period, the interest rate adjusts annually based on market conditions. Hybrid ARMs are often denoted as "5/1 ARM" (the first number represents the initial fixed-rate period, and the second number indicates the adjustment frequency).
- Interest-Only ARMs: With interest-only ARMs, borrowers can pay only the interest on the loan for a period, typically the first 5 or 10 years. During this time, borrowers do not make principal payments, showing lower initial monthly payments. After the interest-only period ends, the loan amortizes over the remaining term, and both principal and interest payments are required.
- Option ARM (Payment Option ARM): Option ARMs offer borrowers multiple monthly payment options, including a minimum payment, interest-only payment, and fully amortizing payment. Borrowers can choose the payment option that suits their financial situation each month. However, if borrowers select the minimum payment option, they may experience negative amortization, where the outstanding loan balance increases over time due to unpaid interest.
- Convertible ARMs: Convertible ARMs allow borrowers to convert their adjustable-rate loan into a fixed-rate mortgage at specified times during the loan term, typically within the first few years. This option provides borrowers flexibility and protection against rising interest rates if they anticipate long-term stability or prefer the predictability of fixed payments.
- Balloon ARMs: Balloon ARMs feature relatively short terms, typically 5 to 7 years, during which borrowers make regular payments based on a more extended amortization schedule, such as 30 years. At the end of the term, the remaining loan balance (balloon payment) becomes due in full, requiring borrowers to either refinance the loan, sell the property, or pay off the balance with other funds.
Pros of Using an Adjustable-Rate Mortgage (ARM) Loan
These are some key pros that borrowers may consider when evaluating an adjustable-rate mortgage (ARM) loan for their home financing needs.
- Lower Initial Interest Rate: ARM loans typically offer lower initial interest rates than fixed-rate mortgages, making them attractive to borrowers who want to take advantage of lower monthly payments at the loan's outset.
- Potential for Lower Payments: During the initial fixed-rate period of an ARM loan, borrowers may enjoy lower monthly mortgage payments than those of fixed-rate home loans with similar terms, allowing them to free up funds for other financial goals or expenses.
- Rate Adjustment Flexibility: ARM loans feature periodic adjustments to the interest rate based on prevailing market rates, providing borrowers with potential opportunities to benefit from decreasing interest rates in the future, resulting in even lower monthly payments.
- Short-Term Housing Plans: ARM loans can be beneficial for homeowners who plan to sell or refinance their home within a few years. They can take advantage of the lower initial interest rate without committing to a long-term fixed-rate loan.
- Potential Savings Over Time: In a stable or decreasing interest rate environment, borrowers with ARM loans may save money over the life of the loan compared to those with fixed-rate mortgages, especially if they plan to move or refinance before the adjustable-rate period begins.
- Rate Cap Protection: Most ARM loans come with rate caps that limit the interest rate's increase during each adjustment period and over the loan's life, providing homebuyers with a measure of protection against significant rate hikes.
Considerations of Using an Adjustable-Rate Mortgage (ARM) Loan
These are some considerations that borrowers may consider when evaluating an adjustable-rate mortgage (ARM) loan for their home financing needs.
- Potential for Interest Rate Increases: One of the main drawbacks of ARM loans is the uncertainty surrounding future interest rate adjustments. If market interest rates rise, borrowers could see significant monthly mortgage payments increase, potentially leading to financial strain.
- Budgeting Challenges: The fluctuating nature of ARM loan payments can make budgeting more challenging for borrowers, as they may not know precisely how much their monthly payments will be. This uncertainty can make it harder to plan and manage household finances effectively.
- Limited Predictability: Unlike fixed-rate mortgages, which offer predictable monthly payments for the entire loan term, ARM loans introduce uncertainty into borrowers' financial planning. Changes in interest rates can have unpredictable effects on monthly payments, making it challenging to anticipate future expenses.
- Potential Negative Equity: In a rising interest rate environment, borrowers with ARM loans may experience slower equity accumulation in their homes than those with fixed-rate mortgages. This can make it more difficult to build wealth through homeownership and may limit options for refinancing or selling the house in the future.
- Refinancing Risks: If interest rates rise significantly after the initial fixed-rate period of an ARM loan, borrowers may find it difficult or costly to refinance their loan to a fixed-rate mortgage. This could leave them vulnerable to higher payments and financial instability.
Take the Next Step with ProFed Credit Union
Ready to explore your home financing options? Contact us today to learn more about our competitive ARM loans and how we can help you achieve your homeownership goals. Our team of mortgage experts is here to guide you through the process and customize a loan solution that fits your needs. Take the first step towards owning your dream home – apply for an adjustable-rate mortgage (ARM) loan today! Equal Housing Opportunity Lender.
