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The Benefits and Drawbacks of Adjustable-Rate Mortgages

The life of an adjustable-rate mortgage (ARM) is characterized by interest rates that adjust periodically. The frequency with which they adjust varies with different loan deals.

Depending on the available deal provided by your lender, the first adjustment period of an ARM keeps the interest rates fixed for a select number of months before they start to adjust. The first adjustment period can even be 1, 3, 5, 7, or 10 years long, depending on the loan deals available. 

The benefits of adjustable-rate mortgages

  • The rates of ARMs remain fixed until the first adjustment period.
    Not only are they low, but they are kept fixed until the adjustment. This gives you some time to refinance before the rates start to change.
  • Lower initial interest rates than that of fixed-rate mortgages.
    You can make a larger down payment as a result of lower initial rates. 
  • More customized than fixed-rate mortgages.
    ARMs have many variations (hybrid ARMs) with different adjustment periods to choose from that keep your rates fixed for that preset period (1, 3, 5, 7, or 10 years) before they adjust. This level of choice allows you to tailor your loan schedule to match your financial situation more closely.
  • Can be more affordable than FRMs in the long run.
    If interest rates are consistently low, you could fulfill your loan obligations more smoothly than you would have with a fixed-rate mortgage.
  • Interest rate caps.
    These limit how high up interest rates can go when they are "fully-indexed" to protect you. Every step of the way, the rates are limited by the initial cap, periodic cap, and the lifetime cap to prevent huge losses. These caps are disclosed at the negotiating table with your lender before signing on the dotted line.
  • Friendly towards refinancing.
    Lenders expect mortgagors of ARMs to refinance their loans within certain time periods.
  • You get a heads up.
    Before every new year, your lender will notify you of interest rate forecasts so you can have time to prepare, save, and switch gears if you decide to refinance. Making it ideal if you wish to move in a few years if interest rates remain too high.

The drawbacks of adjustable-rate mortgages

  • Interest rates follow the market index.
    If the market rates skyrocket, your rates will follow suit and exceed fixed-rate mortgages, and potentially have you losing big.
  • Refinancing is costly.
    Even if you switch to a fixed-rate mortgage at the right moment, doing this can cost hundreds to thousands of dollars. Learn more about the costs of a refinance here.
  • Unpredictability.
    ARMs can involve a lot of guesswork when budgeting and make your finances unstable.
  • Anxiety.
    The lack of control and gambling aspect of ARMs can cause a lot of stress and anxiety.

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