What are adjustable-rate mortgages - and how do you know if one is right for you?
Adjustable-rate mortgages may be attractive to buyers because they tend to offer lower interest rates than 30-year fixed-rate mortgages - at first
If you are looking to buy a home, you may want to consider an adjustable-rate mortgage — but experts say it’s important to know what that means before you commit.
A fixed-rate mortgage has a set interest rate that doesn’t change. But an adjustable-rate mortgage is a loan with an interest rate that could change over time. Part of the rate will be tied to a “broader measure of interest rates, called an index,” according to the Consumer Financial Protection Bureau.
When the index of interest rates goes up, your payment could go up too, the bureau says. Your payment could also decrease as interest rates fall, but that isn’t always the case. Some adjustable-rate mortgages have limits on how high, or low, your interest rate can go.
Adjustable-rate mortgages may be attractive to buyers because, at first, they tend to offer lower interest rates than 30-year fixed-rate mortgages, according to Dr. Ben McCartney, an assistant professor at the University of Virginia’s McIntire School of Commerce, and research affiliate at the University of Virginia’s White Ruffin Byron Center for Real Estate.
“If homebuyers are trying to take their budget as far as they can, the lower rate on the [adjustable-rate mortgage] might be what gets them into a home they're happy about,” McCartney wrote in an email to The Independent.
But when the introductory period ends, the interest rate will change regularly, meaning your payment could go up as well, according to the Consumer Financial Protection Bureau.
There are trade-offs to both adjustable-rate and fixed-rate mortgages, experts say. Here’s how to determine if an adjustable-rate mortgage is right for you.
The pros and cons
The main benefit of an adjustable-rate mortgage is the lower initial interest rate, McCartney said.
“Another advantage is that, if rates do fall in the future, then borrowers' rates will reset down without them having to go refinance,” he said. “This automatic resetting can also be a con, though, if rates rise.”
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Refinancing refers to the process of taking out a new mortgage to pay off your initial one. Homeowners often do this in an effort to lower the cost of their mortgage, according to the financial protection bureau.
Some homeowners prefer fixed-rate mortgages because they “like the certainty of knowing what their mortgage payment will be,” McCartney said. This certainty only applies to the principal loan amount and interest; taxes and insurance costs can still change, he added.
An adjustable-rate mortgage can also be a good option for homeowners who are “confident they’ll be moving before the teaser rate period ends and who really want to buy a house,” McCartney explained.
But don’t assume you’ll be able to refinance your loan or sell your home before the interest rate changes, the Consumer Financial Protection Bureau warns.
“The value of your property could decline, or your financial condition could change. If you can't afford the higher payments on today's income, you may want to consider another loan,” the agency recommends.
A checklist of considerations
McCartney urges homeowners to consider two major factors when weighing an adjustable-rate mortgage.
“The biggest factors to keep in mind are: how long you'll be in the house and how much you value the certainty of knowing what your payments will be in the long run if you're not planning on leaving,” he said.
The Consumer Financial Protection Bureau also provides a list of factors to consider. These include:
- “How high or low your interest rate and monthly payments can go with each adjustment.”
- “How frequently your interest rate will adjust.”
- “How soon your payment could go up.”
- “If there is a cap on how high your interest rate could go.”
- “If there is a limit on how low your interest rate could go.”
- “If you will still be able to afford the loan if the rate and payment go up to the maximums allowed under the loan contract.”
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