Adjustable Rate Mortgages – Cheaper Payments Or Crazy Risk?

cash in envelope and other cash

When mortgage rates rise, purchasing a home gets more expensive for the vast majority of people. The 30-year fixed-rate mortgage is a tried and true solution that continues to be the most common. Mortgages lasting 15 years at a fixed rate are also pretty common, although significantly more expensive month-to-month.

There is a different sort of option for buying a home though, that involves some risk, but costs less every month: The adjustable-rate mortgage (ARM). With an ARM, your rate isn’t fixed for all 30 years (assuming a 30-year mortgage). Instead, the rates will be fixed for the first 5 or the first 7 years only, then get reset after that. But the real estate community is still skeptical of clients using ARMs.

So why the hate? Back around 2008, adjustable-rate mortgages were blamed for a lot of the chaos in the housing market. Basically, lots of people had ARMs that they couldn’t afford and had to give up their homes. The product isn’t exactly the same today though, the mortgage industry and government learned from that brutal experience. Back then, these loans were set up to have payments covering only interest on the home, so that homeowners never gained any equity.

Today, ARMs are designed to pay both principal and interest, so homeowners are gaining equity in the home every month and are at much less risk of losing a home if rates go up or prices go down. They actually work exactly like a fixed mortgage, with the exception that that rate can adjust after the initial set period. Given that the vast majority of people don’t stay in a home for close to 30 years, this seems to be a pretty reasonable path to save money up-front and risk increased payments if you stay for many years.

Every situation is different, but for a client that is probably going to move in under 7 years, it is almost always cheaper to do a 7-year ARM. If a client is definitely going to move in 5 years or less, then a 5-year ARM will be even cheaper, this might be someone that knows they are only living somewhere for work or school for a few years. Finally, it is more of a gamble, but ARMs can work for people that want to save some money the first few years and let the rate reset later. As risky as it sounds, when rates are already high and cash is already tight, it isn’t always as bad an idea as people think. Whether advising friends, family, clients, or your own situation, don’t rule out adjustable-rate mortgages, it is really just another tool available to homeowners.