A fixed-rate mortgage allows a borrower to pay the same amount per month, and this amount doesn’t vary even if there’s interest rate fluctuation in the market. Although there are advantages to this type of mortgage, you can consider trying the adjustable-rate mortgage to lower your monthly payment if you want to save money. 

Yes, there’s a chance you can avail of a lower interest rate if you go for an adjustable-rate mortgage. But, as its name suggests, the interest rate may adjust according to market factors. It means your monthly payment could go lower or higher. 

Here are things you should know about switching from a fixed-rate mortgage to an adjustable-rate mortgage to save on your monthly loan payment.

Adjustable-Rate Mortgage: Fully Explained

An adjustable-rate mortgage (ARM) is a house loan with an interest rate that can vary based on market factors. Initially, a lower interest rate is provided to borrowers, which makes ARM a better alternative if you want to pay lower monthly payments while starting out.

However, when the teaser period ends, your interest rate will be based on the market index. So, it could be either lower or higher. 

Available ARMs on the market today are referred to as 3/1, 5/1, 7/1, and 10/1 ARMs. The first number refers to the years when your interest rate stays the same. After that period ends, your rate changes once every year based on the market index stipulated in the mortgage agreement. 

Most lenders offer a cap on the interest rate as stated in the agreement. It means that you’ll only be paying a rate not higher than the cap rate even though the index says so. 

Payment Structure of an ARM

Let’s use, for example, the 5/1 adjustable-rate mortgage for you to get an idea of what ARM payments look like. Say, the teaser rate is 5% on your ARM, and the cap is 2%. Your total rate won’t exceed 7% once the teaser rate period is over. 

Different lenders have different caps on their adjustable-rate mortgage. So, never be afraid to ask the lender regarding the payment structure of your new home loan. 

The Tainted History of Adjustable-Rate Mortgage

The United States housing bubble in the early 2000s brought a mortgage crisis that tainted the name of ARMs. ARM providers didn’t verify many of the borrowers’ income and assets. When the adjustment period started, it created an exorbitant increase in interest rates,  and borrowers couldn’t afford to pay their home loans, which resulted in mass foreclosures. 

However, adjustable-rate mortgages are different nowadays compared to that era. Today, we have consumer protection laws and underwriting guidelines that safeguard lenders and borrowers of ARMs. 

There’s now also standard paperwork for each mortgage provider, and this makes it easier to understand by borrowers. Moreover, there’s an asset and income verification put in place to ensure that lenders are only lending to qualified borrowers. 

Still, adjustable-rate mortgages come with financial risks. One of the cons of ARMs is that you’re not sure whether your interest rate will increase or decrease when the teaser rate period ends. 

The Case for Adjustable-Rate Mortgage

Switching to an adjustable-rate mortgage can be beneficial to you if you do the math first. If you think you can save money on your monthly loan payment, you can go for it. There are lenders that offer lower rates and fees for their ARMs. That’s good news for those who want to save on their monthly payments. 

Moreover, it’s a good decision to convert your fixed-rate mortgage to an ARM if you’re not planning to stay in the property much longer and sell it before the interest rate gets higher. 

The Cost of Refinancing to An Adjustable Rate Mortgage

You should consider the refinancing cost to an adjustable-rate mortgage before switching to it. The move involves paying appraisal fees, origination fees, relevant title fees, and closing fees. 

Before making your move, be smart by comparing the new loan’s savings on monthly payments to the potential refinancing cost. It’s also crucial to develop a plan when there’s a rate spike when the adjustment period begins. 

Make sure to look for the best offers in terms of interest rates and fees if you’re considering switching to an adjustable-rate mortgage. Also, remember that it’s not automatically easier to refinance with the same lender as your fixed-rate mortgage. 

Takeaway

Converting your fixed-rate mortgage to an adjustable-rate mortgage may have its risks and benefits. Before deciding on this move, make sure to do the math on whether you really can save money on your monthly payments.

While you can avail of lower interest rates during the teaser period, you can’t predict whether you’ll be paying a higher or lower rate after the period ends. So, be sure to read more about ARMs and shop around for the best offers available today.