Adjustable-Rate Mortgage (ARM) – Loan Explained

Adjustable-rate mortgages have gotten a bad rap over the years (especially after they helped along the American economy’s near-collapse in 2008), but hey, everybody makes mistakes, right? But seriously, this type of loan does come in handy for certain kinds of buyers. 

Those looking for the very best interest rate, those who can handle shorter-term loans, and maybe even a few financially fit risk-takers often find that an adjustable-rate mortgage is exactly what they need. Does this sound like you? Do you like to live just a little dangerously? Might this less-conventional loan be the ticket to your next home purchase?

To get a handle on this wild world of adjustable-rate mortgages, we’ve posed and answered three basic questions, helping you determine if this often-avoided kind of loan might actually be your best option.

What Is It?

An adjustable-rate mortgage (ARM), or sometimes called a variable rate mortgage, is exactly what it sounds like: a mortgage with an interest rate that adjusts. Unlike the more conventional fixed-rate mortgage, which stays constant over the entirety of the loan, an ARM allows for fluctuation. It does begin with an initial period in which the interest rate remains steady (typically 3, 5, 7, or 10 years), but following this attractive opening rate, the interest is subject to change based upon whatever index to which it is tied. For a closer comparison between these two types of mortgages, check out a previous blog on this very topic.

Why Would I Want It?

Now that we have a grasp on what it is let’s explore why anyone would want it. Surprising as it may seem, there are many scenarios where this type of loan comes in handy.

1. Folks Looking for a Quick Flip

Homebuyers who know they are not likely to stay in the home for very long (ideally a duration shorter than the initial fixed-rate) are often enticed by the low introductory interest rate available on adjustable-rate mortgages. An ARM allows folks to buy with “cheap money,” and if they do not intend to hold the loan by the time those rates are open to change, this kind of loan is perfect.

2. People Who Stand to Collect Cash in the Near Future

Sometimes people need to purchase a home while still holding on to a previous property. This might be another situation in which an ARM proves suitable. Folks with low cash in hand at the start of a loan but who are apt to increase their income somewhere in the near future (like with the sale of another house) might jump on the low introductory rates offered with an ARM knowing that, should those rates increase and drive up their payments, they will be better able to handle such a jump down the road.

3. Buyers Using the Property as a Rental

 Homebuyers seeking to use the purchased property as rental income might also find an ARM to be their best bet. Low payments on the front end, prior to securing renters, allow an investor to pay the bills. Once rates adjust a few years into the loan, there has already been a substantial income stream compiling, so the owner is less affected by potential rate hikes.

4. Risk Takers with Money on Hand

There is another kind of buyer who might find these types of loans attractive – the risk-taker. A buyer who has money to burn and is willing to trust they can pay off the loan in full or offload the property altogether should rates jump to unreasonable levels can utilize an ARM without much fear of the repercussions. Folks who are financially comfortable (or maybe even a little more than comfortable) are usually the ones best suited for these types of real estate moves.

How Can It Go Wrong? 

Well, just like anything else does, really. Job loss, natural disasters, market crashes – all of these things (and a mountain of others) could, unfortunately, charge right into the middle of that ARM and wreck everything. These factors could, of course, affect your ability to pay a fixed-rate mortgage, as well. At least with a fixed rate, though, the mortgagee knows the maximum amount they are in for each month. With an adjustable-rate, that payment could increase right when money is the tightest.

Even buyers who think they have a handle on what’s to come sometimes get it wrong. A buyer is set on flipping a house within three years, then discovers the home has much more significant issues than they originally realized. An investor plans to rent out the property they just purchased, and then two huge apartment complexes are constructed down the street, flooding the rental market. The unexpected can always creep in, taking buyers by surprise.

With any home purchase and corresponding mortgage, it is important to exercise sound judgment and research all the options before signing on the dotted line. Maybe the steady pace of a fixed mortgage is more your style, but then again, those attractive rates on the ARM might get you exactly what you’ve always wanted: a beautiful new home and a little walk on the wild side.