Many home buyers use a home loan to finance their purchase. Your home loan payment can be a major factor in your personal budget for years or decades in many cases, so you understandably want to set up the best loan terms possible. Many people opt for a fixed rate loan because of the benefit associated with having fixed terms and a firm payment amount throughout the life of the loan. However, an adjustable rate mortgage is another option to consider in some cases, and there are instances when this is actually a more attractive and beneficial option than a fixed rate loan. With a closer look at what an adjustable rate mortgage is and when you should apply for one, you can be a more educated home loan applicant.
What Is an Adjustable Rate Mortgage?
An adjustable rate mortgage is simply a home loan that has a non-fixed interest rate. However, the terms of the rate adjustment can vary. For example, some rates adjust every six months, and others may adjust every one to two years. Usually, the loan terms that you agree to indicate that the rate will adjust at a certain margin over a defined index. For example, if the index that your rate is tied to is the Prime Rate, your loan terms may state that your rate will adjust to two percent over the Prime Rate every six months. Therefore, if the Prime Rate index rises, your own mortgage rate and payment will also increase. Usually, there is a defined minimum and maximum amount that your home loan rate can be. This gives you some peace of mind that the rate cannot escalate to an exceptionally high amount.
The Pros of an Adjustable Rate Mortgage
One of the most significant benefits associated with an adjustable rate mortgage is the rate itself. The starting rate usually is much lower than the market fixed rate at the time. This means that you can save a considerable amount of money on your mortgage payment during the initial period before the rate adjusts. If rates stay low, this ability to save money can continue. Another important benefit of this type of loan is the cap on how high the interest rate can be. There is some risk associated with choosing an adjustable rate mortgage because rates can rise, but the cap on the rate helps you to minimize this risk so that you can more comfortably take advantage of the benefits of getting an adjustable rate home loan.
The Cons of an Adjustable Rate Mortgage
As you might imagine, there are downsides associated with an adjustable rate home loan as well. There are instances when the index rate that your mortgage is tied to can escalate quickly. Index rates are usually linked to major economic factors, so it can be difficult to determine if and when your rate will increase. Even those who play close attention to the economy can be caught off-guard by a sudden increase in rates. Some homeowners who have this type of mortgage are not financially prepared for a sudden and large rate and mortgage payment increase. The possibility that this could happen can make it difficult to prepare your budget in many cases. There are instances when an adjustable rate home loan payment becomes unaffordable for the homeowner, and the homeowner may be forced to refinance or to sell the home. This could be at an inopportune time when the financial or housing markets are in decline, and this could lead to further financial issues for the individual for years to come.
When an Adjustable Rate Mortgage Makes Sense
Some home loan applicants want to enjoy the peace of mind that comes with having a steady mortgage payment throughout the life of the loan, but there are instances when opting for an adjustable rate mortgage makes sense. For example, if current rates are very high and are projected to decrease in the near future, an adjustable rate mortgage makes it easier for you to take advantage of lower future interest rates without having to refinance your mortgage. Another time when an adjustable rate mortgage makes sense is when you only plan to be in the home for a few years. The initial starting rate on an adjustable rate mortgage is usually significantly lower than a fixed rate mortgage. Therefore, if you opt for an adjustable rate loan, you may enjoy lower monthly payments for most or all of the time that you plan to own the home. These are only a few of the instances when an adjustable rate loan is more preferable than a fixed rate loan.
Important Steps to Take Before Finalizing Your Loan Request
As you can see, there are notable risks associated with applying for an adjustable rate loan. Most significantly, you run the risk of having your mortgage payment escalate to a point that could be unaffordable for your budget. It is wise to review and understand all of the terms of your adjustable rate mortgage before you sign the papers. Pay attention to the maximum amount that the rate could increase, and estimate what your monthly payment would be if this happens. Review your budget to ensure that you can afford this potential mortgage payment. It is also a smart idea to save at least six months’ worth of your highest possible mortgage payment in your savings account. This will ensure that you can pay your housing payment in an escalating rate environment if you lose your job or are dealing with other financial issues.
There are instances when a fixed rate loan is a better idea for a home loan applicant. However, there are substantial benefits associated with applying for an adjustable rate loan in some situations as well. As a home buyer, you should understand your current economic climate as well as your personal financial situation. When you relate these factors to your loan options, you will be able to better determine if an adjustable rate mortgage is right for you. Feel free to reach out to Evergreen Properties and Investments for any further questions about adjustable rate mortgages.
From the Author: My name is Dan Barcelon and I believe that Real Estate can be one of the most valuable assets you’ll ever own. I’m dedicated to educating and guiding my clients on how to manage and leverage their homes to create an Evergreen legacy for themselves and their family. I primarily consult both home buyers and home sellers on reaching their personal and financial goals through Real Estate in the following cities of Southern California: Long Beach, Carson, Cerritos, Signal Hill, Torrance, Lakewood, Cypress, Downey, Bellflower, Norwalk, Wilmington, La Palma, and Artesia.
If you’d like to discuss if buying, selling, or investing in real estate is right for you at this time, feel free to reach out. You can call/text me at 562-270-5812, or you can e-mail me at danb@EPIrealestate.biz.