There’s so much flexibility in our lives, we hardly notice it. Imagine if you couldn’t adjust the brightness and volume on your phone. Or if your car seat didn’t move forward and backward. What if your TV had no remote control and you had to get up every time you wanted to change the station?
But there’s one facet of life where rigidity might be good for you. Your mortgage.
Most mortgages in this country aren’t flexible at all. Roughly 9 in 10 mortgages are for 30 years at a fixed rate. In other words, you pay the same interest rate the first month as you do 360 months later. That makes it easy to budget, because your payments are predictable.
Then there are adjustable-rate mortgages, or ARMs for short. They’re making a comeback.
What’s an ARM?
ARMs are just like a fixed-rate mortgage – for a few years. Typically, you pay the same interest rate for anywhere between 3 and 10 years. Then things get interesting.
You enter the “adjustment period,” where your interest rate constantly changes, sometimes as often as every six months. If you’re lucky, those rates don’t jump by much or even anything. If you’re unlucky, you can pay a lot more for the same home.
You can learn more about the different types of mortgages here, but let’s talk about why you should probably keep ARMs at arm’s length.
Why are they risky?
It typically costs less to get an ARM than a fixed-rate mortgage, because lenders know history is on their side. When you enter your adjustment period, chances are interest rates will be higher than what you’re currently paying. If that wasn’t the case, lenders wouldn’t offer ARMs in the first place. Let’s face it, lenders are in business to make money – and the profit comes from you.
If your interest rate rises a little, then you pay more but go on with your life. But what if the interest rate – which is pegged to what’s happening in the country at the time – rises a lot? As a housing counselor, I’ve heard horror stories of homeowners defaulting on their ARMs because they just couldn’t afford the higher rate. That can even lead to foreclosure.
Why are they popular again?
ARMs have doubled since the pandemic, according to The Wall Street Journal. The reason is no mystery.
“Americans are reconsidering adjustable-rate mortgages as a way to cut the cost of buying a home in the short term,” The Journals reports. “Persistently high mortgage rates have more home buyers turning to ARMs, which tend to have lower rates for a set number of years before floating in tandem with market rates.”
To make an ARM work for your budget, you probably need to refinance before you enter the adjustment period – if you can get a lower interest rate. Otherwise, you’re at the mercy of the market at the time your rates can fluctuate.
Most of us don’t have the time or expertise to continually monitor interest rates and make an educated guess when to refinance. But if you can’t afford a home without an ARM, what else can you do?
A better plan
Before you even consider which mortgage to get, consult an expert. Of course, anyone can call themselves an expert. How do you find a real expert who will put your interests ahead of their own?
Of course, as Consolidated Credit’s director of housing counseling, I’m biased. Government-certified housing counselors in your state are hands-down the best resource for homebuyers. They can lay out all your options so you can make informed choices. Best of all, their advice is free.
To find counselors in your area, the U.S. Department of Housing and Urban offers this search tool. Before you consider an ARM, reach out to a counselor. It can save you a lot of money and stress.
