Adjustable-rate mortgages may be a good option for borrowers who plan to finance a property for a relatively short period of time, such as three to five years. ARMs may offer lower “preliminary” rates that are generally lower than fixed mortgage rates. And when limits apply, an ARM may be the best overall option. An ARM may be a good idea if your life is likely to change in the next few years, for example, if you plan to move or sell the house.
Introduction
An adjustable-rate mortgage (ARM) is a type of home loan that offers a lower initial interest rate than a fixed-rate mortgage. However, the interest rate can change periodically, which makes it a riskier loan option for borrowers. In this article, we will explore the pros and cons of an ARM loan to determine if it is ever a good idea for veteran borrowers. If you are a veteran looking for VA lenders near me we recommend National VA Loans! It you have a VA home loan question call them at (855) 956-4040.
What is an ARM Loan?
An ARM loan is a type of home loan where the interest rate is adjustable and changes periodically. The initial interest rate is usually lower than a fixed-rate mortgage, making it an attractive option for borrowers who want to save money in the short term. However, after the initial fixed-rate period, the interest rate can adjust annually based on the index rate and the margin.
How Does an ARM Loan Work?
The interest rate on an ARM loan is typically fixed for a set period, usually 5, 7, or 10 years. After the fixed-rate period, the interest rate can adjust annually, based on the index rate and the margin. The index rate is based on the performance of a financial index, such as the London Interbank Offered Rate (LIBOR), and the margin is a fixed percentage added to the index rate.
Advantages of an ARM Loan
Lower Initial Interest Rate
One of the biggest advantages of an ARM loan is the lower initial interest rate. This can save borrowers money in the short term, especially if they plan to sell or refinance their home before the interest rate adjusts.
Flexibility
Another advantage of an ARM loan is the flexibility it offers. Borrowers can choose the initial fixed-rate period that works best for their needs, and they can also make extra payments to pay down their principal balance faster.
Higher Loan Amounts
ARM loans may allow borrowers to qualify for a higher loan amount than they would with a fixed-rate mortgage. This is because the initial lower interest rate reduces the monthly mortgage payment, which can make it easier to meet the lender's debt-to-income ratio requirements.
Disadvantages of an ARM Loan
Interest Rate Risk
One of the biggest disadvantages of an ARM loan is the interest rate risk. After the initial fixed-rate period, the interest rate can adjust annually, which means the monthly mortgage payment can increase significantly.
Uncertainty
Another disadvantage of an ARM loan is the uncertainty it creates for borrowers. They cannot predict what the interest rate will be in the future, which makes it difficult to plan for their monthly mortgage payment.
Negative Amortization
ARM loans may also have negative amortization, which means the monthly mortgage payment may not cover the interest due, and the unpaid interest is added to the principal balance. This can increase the loan balance and make it more difficult to pay off the loan.
When is an ARM Loan a Good Idea?
An ARM loan may be a good idea for borrowers who:
- Plan to sell or refinance before the interest rate adjusts
- Expect their income to increase significantly in the future
- Want to qualify for a higher loan amount
- Have a lower credit score and cannot qualify for a fixed-rate mortgage
When is an ARM Loan a Bad Idea?
An ARM loan may be a bad idea for borrowers who:
- Plan to stay in their home for a long time
- Have a fixed income and cannot afford a higher monthly mortgage payment
- Want predictable monthly mortgage payments
- Are risk-averse and do not want to take a chance on interest rate changes
Conclusion
In conclusion, an ARM loan can be a good option for some borrowers, but it is not the right choice for everyone. Borrowers should carefully consider their financial situation and future plans before deciding on an ARM loan. They
