When is an adjustable-rate mortgage the right money move?

An adjustable-rate mortgage (ARM) product might not be the perfect product for every homebuying situation. There are times, however, when the potentially lower initial rate on an ARM is a great move — and might actually save you money in the long run. 

First, a refresher: An ARM is a loan with an interest rate that changes over time. Here at UBT, we offer what is known as a 7/6 mo. ARM. This means your initial interest rate is locked in for the first seven years of the loan. After that seven-year period, the interest rate is variable and can adjust every six months for the remainder of the loan. If you’d like to dig in a little further, we have another helpful blog that will help you better understand these unique loans. 

Now, let’s take a quick look at three times when taking an ARM product could allow you to flex your financial muscle a bit, and some situations where an ARM might not be the best product.

PRO: Your new home is short-term. ARM products offer an initial interest rate that may be better than a fixed-rate mortgage for a specific amount of time. If you’re going into your home purchase knowing you’ll be moving before that initial interest rate period is over, it’s wise to choose an ARM product to potentially save on interest.

For example, let’s say you’re home shopping and find a house that will suit your needs for about five years until you’re ready to upgrade to a more permanent house. It makes sense to choose an ARM product like UBT’s 7/6 mo. ARM, knowing you won’t have to risk your interest rate increasing when the initial period expires and the rate adjusts accordingly.

CON: Your home is long-term. If you’re buying a house you plan to be in long after the initial rate period, an ARM will leave your house payment up to the ebbs and flows of the national rate environment. If rates are unstable like they were during the pandemic and afterward, you could potentially experience an ever-changing house payment. This is also something to keep in mind even if you’re planning to be in a home short-term, because sometimes life gets in the way and you may end up staying longer than anticipated, opening yourself up to those changing rates.

PRO: You anticipate earning more. If you’re buying a house early in your career, you can likely anticipate your income increasing a bit during your initial period. Take, for example, a 7/6 mo. ARM product. So much growth can happen in your career in its first seven years, so you can likely anticipate your income increasing.

The reason you’ll want to have a higher income at the end of the initial period is that if you’re enjoying the low initial ARM rate and your rate increases your mortgage payment significantly because of the rate environment, you’ll have some financial breathing room and it won’t be devastating financially. Thankfully, there’s also an interest rate cap that keeps you under a certain payment no matter what happens with rates.

CON: Your income doesn’t increase much. If you anticipate your income increasing significantly, you’ll want to make sure that your career trajectory goes in that direction. That can put a lot of pressure on you to make more money so that you can outpace your adjustable rate. If your income doesn’t go up as much as you envisioned, it might put you in a financial crunch.

There are ways to prevent this situation from ruining you financially, however. Your ARM will have an interest rate cap, so it’s good to know what the maximum payment will be before you sign the closing paperwork. If you plan for that payment before you close on the mortgage and it can be worked into your budget regardless of an increase in income, the ARM might still make sense.

PRO: You’ll have it paid off. If you’re in a financial position to make regular monthly payments toward principal and have your loan paid off during your initial rate period, an ARM is a great way to save money. By enjoying the potentially lower rate offered by an ARM product, you could pay more toward the principal on the mortgage and less toward interest.

CON: Life happens. Say you’re planning on paying extra and having it paid off during the initial period and have a financial setback like a medical issue that pulls money from part of that payment. That might put you in a situation where you’re paying beyond the initial period and that payment could increase.

If you’re considering whether you should take on a fixed-rate or adjustable-rate mortgage, our people are here to help. Talk with one of our loan officers today to see which products make the most sense for your unique financial situation.