What Is an Adjustable Rate Mortgage, and Who Is it For?
Taking out a mortgage is one of the most exciting and daunting financial transactions that anyone will make during their life. There is the excitement of buying your new home, mixed with the relatively large commitment you are making in terms of monthly repayments. It is critical that anyone applying for a mortgage should understand all of the options available to them and make an informed decision.
What Is an Adjustable Rate Mortgage?
An adjustable rate mortgage (ARM) is a type of mortgage where the interest rate can change during the course of the loan. This rate can either increase or decrease, which will have an immediate impact on the cost of your monthly repayments.
In most cases, the interest rate available for an ARM (at least initially) will be lower than the rate available for a fixed-rate mortgage. This is because the lending institution is taking more of a risk with a fixed-rate mortgage, as there is a chance the interest rate at which they can borrow money (which banks do quite frequently) during the course of the loan could increase. This is not good for their bottom line – they are paying more for the loans they take out, and making the same from the loan you took out from them.
However, if you opt to sign up for an adjustable rate mortgage, you are taking the risk that interest rates will not increase above the best fixed rate you could sign up for.
In summary: fixed rate mortgages put more risk on the lender, where adjustable rate mortgages put more risk on the person taking out the loan.
Who Should Choose an Adjustable Rate Mortgage?
As with a lot of financial decisions, this decision will be highly influenced by your ability to take on risk. At the current time in the economic cycle, the vast majority of people are choosing to take out a fixed rate mortgage. This is because rates are historically low, and the general consensus of opinion is that the only direction interest rates can go is up.
However, about ten years ago, many people signed up for a fixed-rate mortgage at 5 to 7 percent. When the rate dropped drastically to 1 or 2 percent, they were forced to overpay for many years.
One life situation in which it might make sense to choose an adjustable-rate mortgage is if you are at the early stage of your career and expect your income to increase over the next few years. Because an adjustable rate mortgage is generally cheaper than a fixed rate, it might be a better option for your first couple of years. Just be aware that if rates do increase, you must be able to make the higher payments.
For such an important decision, I would always advise speaking to a mortgage adviser who can help explain all of the various options available to you. I spend the time with every one of my clients to ensure they not only make the right decision for their situation, but that they understand the reasons for their decision.
You could be paying back your mortgage for 30 years, so however tempting it might be, do not rush into any decisions. Give me a call today and book an appointment!
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