• Menu
  • Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer

NewHomeSource

  • Learning Center
  • Just For You
    • First Time Home Buyers
    • 55 Plus
    • International Buyers
    • For The Military
    • Single Women
  • Home Types
    • Custom Homes
    • Condos & Townhomes
    • Luxury Homes
    • Tiny Houses
    • Manufactured Homes
  • Resources
    • Home Buying Tools
    • Mortgage Calculator
    • Home Affordability Calculator
    • Trustbuilder Ratings & Reviews
  • Learning Center
  • Just For You
    • First Time Home Buyers
    • 55 Plus
    • International Buyers
    • For The Military
    • Single Women
  • Home Types
    • Custom Homes
    • Condos & Townhomes
    • Luxury Homes
    • Tiny Houses
    • Manufactured Homes
  • Resources
    • Home Buying Tools
    • Mortgage Calculator
    • Home Affordability Calculator
    • Trustbuilder Ratings & Reviews
Home ยป Financing ยป Is an Adjustable-Rate Mortgage a Smart Move for Your Home Purchase?

Is an Adjustable-Rate Mortgage a Smart Move for Your Home Purchase?

mortgage rate

If you find yourself looking at one of those online mortgage rate charts, an adjustable-rate mortgage can look pretty tempting, particularly with those low initial interest rates. While this type of loan has its advantages, it isnโ€™t right for everyone. In fact, an adjustable-rate mortgage could end up cost you more (lots more) in the long run.

Want to see if an adjustable-rate mortgage is a good fit for your needs? Letโ€™s dive in.

Whatโ€™s an Adjustable-Rate Mortgage?

To start, letโ€™s dive into what an adjustable-rate mortgage (ARM) is in the first place. The majority of U.S. mortgages are fixed-rate mortgages, which offer you a single interest rate across the entire loan term (usually 30 years).

Adjustable-rate mortgages, on the other hand, have rates that can change. Hereโ€™s how Bobby Heytota, director of secondary markets for online lender Better.com, explains it: โ€œAdjustable-rate mortgages have a fixed rate for a number of years and then adjust based upon a benchmark rate, with a margin added on top.โ€

ARMs are typically expressed with two numbers, with the first number indicating the length of the fixed period and the second representing the adjustable term. For example, with a 5/1 ARM, youโ€™d have a fixed rate for the first five years. After that point, your rate would adjust once per year (indicated by the one) based on the index your loan is tied to.

 โ€œARMs typically have a lower initial rate compared to fixed-rate mortgages,โ€ Heytota says. But after that? Thereโ€™s a risk the rate could increase โ€” taking your monthly payment and overall housing costs with it. When youโ€™re trying to pay your mortgage every month and still have enough socked away for a rainy day, even the smallest divergence in interest rates can make all the difference.

Pros and Cons of ARMs

The biggest advantage of an ARM is that you can get a lower up-front interest rate than on fixed-rate loans. In many cases, 5/1 ARMs clock in significantly lower than the average 30-year mortgage. Often, the spread is 0.75 percent or more.

That means lower monthly payments and less interest paid at the beginning of the loan. Thereโ€™s also the chance your rate could decrease in the future if the benchmark index itโ€™s tied to falls. That would lower your payments and overall housing costs even further.

Another benefit is that you can pay down your balance faster with a lower interest rate. That equals more equity when it comes time to sell.

On the downside, thereโ€™s a lot of risk involved with ARMs. Most notably, your rate and payments could increase down the line, and it could put a serious financial strain on your household. ARMs are also pretty complex, so if you use one, youโ€™ll want to be extra diligent about knowing the fees, rate caps, penalties and other features of your loan.

When to Use an ARM

Deciding whether to use an ARM is all about weighing risk versus reward. If youโ€™re only going to be in the home long enough to enjoy the low-rate period, then the choice is a slam dunk. (Maybe your job is only a two-year assignment or you plan to move to a larger place when you have kids in a few years.)

Remember: Thereโ€™s no way to predict the future. Plans change or it could be hard to sell your home before your rate adjusts. Make sure you have a contingency plan in place in case that happens.

Super-low rates may also warrant the extra risk of an ARM. As Heytota says, โ€œIf the initial rate is low enough compared to where fixed mortgage rates are, it compensates you for the inherent risk that your rate may go up once it begins to adjust.โ€

Finally, ARMs might be a fine choice if youโ€™ve got strong income or expect your earnings to rise before your initial rate period ends. Youโ€™ll just want to make sure youโ€™re budgeting ahead of time for any potential increase that may hit.


Generally, an ARM can be a good idea if:

  • You only plan to own the home a short amount of time.
  • You have the income to cover a potential payment increase in the future (or you expect your income to increase soon).
  • Rates are significantly lower than fixed-rate loans and youโ€™re willing to refinance before your low-rate period expires.

When Not to Use an ARM

An ARM isnโ€™t a great option if you plan to be in the home for the long haul, as the risk of a rate increase is pretty high. If youโ€™re on a fixed income, have a tight household budget or just arenโ€™t sure where youโ€™ll be financially in a few years, theyโ€™re not a smart bet either.

Additionally, if thereโ€™s only a small difference in interest rates between adjustable- and fixed-rate mortgages, you may want to steer clear, too. According to Heytota, if ARM rates are only 0.25 percent or 0.50 percent lower than a fixed-rate mortgage, itโ€™s probably not worth the risk โ€” at least if you plan to stay in the home for a while. 

The Bottom Line

Always weigh your mortgage options โ€” and the accompanying risks โ€” carefully. Consider your long-term goals as a homeowner, the stability of your income and the level of risk your household finances can handle. And if youโ€™re still not sure, consult a mortgage broker or loan officer. Theyโ€™ll be able to point you in the right direction for your budget.

Aly Yale

Iโ€™m a freelance writer and journalist from Houston, covering real estate, mortgage and finance topics. See my current work in Forbes, The Motley Fool, The Balance, Bankrate, New Home Source and The Simple Dollar. Past gigs: The Dallas Morning News, NBC, Radio Disney and PBS.

Get our FREE guide on how the home construction process works

By downloading our guide, you can also look forward to receiving our New Home 101 short email series. You may opt out of this subscription any time you wish.

Previous Post: «Colorado Top 10 Safest Cities in Colorado
Next Post: Top 10 Safest Large Cities in California California»

Reader Interactions

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Primary Sidebar

Search new homes

New Home 101

  • The Basics of Newly Built Homes
  • Why Buy a Newly Built Home
  • Shopping for Your New Home
  • Building Your New Home
  • Designing Your Dream Home
  • Buying Your New Home
  • Moving Into Your New Home
  • New Home Glossary

Footer

Quick Links

  • 55+ Communities
  • Condos & Townhomes
  • Custom Home Buyers
  • First-Time Buyers
  • Luxury Homes
  • Manufactured Homes

Related Sites & Resources

  • Learning Center
  • CasasNuevasAqui.com
  • HomLuv.com
  • Real Estate Professionals
  • NewHomeSource App
  • Trust Builder Ratings & Reviews

Helpful Links

  • About Us
  • Contact Us
  • Builders: List your homes!
  • Unsubscribe
  • Terms of Use
  • Privacy & Cookies
  • Do Not Sell My Personal Information

Copyright © 2022 ยท Builders Digital Experience, LLC. All rights reserved. NewHomeSource.com is a trademark of Builders Digital Experience, LLC and all other marks are either trademarks or registered trademarks of their respective owners.