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Don’t get an adjustable-rate mortgage without reading this.
Key points
- Mortgage rates have been going up in recent months.
- An ARM can seem like a good loan option because of its lower starting interest rate.
- ARMs can become much more expensive over time.
Mortgage interest rates have been steadily rising and are now above 5% for the first time in many years. This may be disappointing to home buyers who will see their home loans cost much more than similar mortgages did last year.
If you are buying a property and are concerned about high rates, a particular type of mortgage may seem attractive because the financing charges seem lower. But opting for this loan rate option could end up being a costly mistake in the end. Here’s why.
Don’t assume this low-rate loan option is the best choice
When shopping around for a home loan, chances are an adjustable-rate mortgage (ARM) is going to appear to be the cheapest option at first glance.
ARMs will almost always have lower starting interest rates than their fixed-rate competitors. For example, as of June 10, 2022, the average interest rate on an ARM is 4.428% while the average interest rate on a 30-year fixed-rate loan is 5.477%. That’s more than 1 percentage point difference between the rates.
Obviously, such a big discrepancy means an ARM looks like a far better deal. But the problem is, ARMs can adjust after an initial period when the rate is locked in. Fixed-rate mortgages cannot. So, if you got a 30-year mortgage at the average 5.477% rate, you would know that your rate is not going to change over the entire repayment period. But that’s not the case with your ARM.
Here’s why an ARM could cost you
An adjustable-rate mortgage is a high-risk option that could end up costing you money in the end because the interest rate is tied to a financial index. If the index shows rising rates, your mortgage financing charges will go up.
There are different rules for exactly how much rates could go up with an ARM. In some cases, it could be as much as 5 percentage points. This could lead to a new rate of 9.428% if the worst happens and your rate goes up as much as it is allowed to. That’s obviously much higher than the 5.477% 30-year fixed-rate mortgage loan.
You are taking a huge chance when it comes to getting an ARM, especially as rates have been rising steadily and are likely to continue doing so at least for the near-term as the Federal Reserve tries to fight inflation. If rates go up enough, your mortgage payment could end up being much more expensive or even so unaffordable that you could face foreclosure.
Now, you may assume refinancing your ARM to avoid this fate would be possible, but if future rates are higher or you are having any financial issues, you might be unable to refinance and could get stuck with your high-rate loan. You probably don’t want to take this big chance when it comes to an asset as valuable as your home, so many people will find the fixed-rate option to be the better bet even though it means paying more upfront.
The Ascent’s Best Mortgage Lender of 2022
Mortgage rates are on the rise — and fast. But they’re still relatively low by historical standards. So, if you want to take advantage of rates before they climb too high, you’ll want to find a lender who can help you secure the best rate possible.
That is where Better Mortgage comes in.
You can get pre-approved in as little as 3 minutes, with no hard credit check, and lock your rate at any time. Another plus? They don’t charge origination or lender fees (which can be as high as 2% of the loan amount for some lenders).
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