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Your Starter Home: What to know about an Adjustable Rate Mortgage

December 22, 2016 at 4:24 PM

If you’re looking to purchase your first home, then make sure you look into and consider an Adjustable Rate Mortgage (ARM). An ARM can be a powerful tool for first-time homeowners.

adjustable rate mortgageAn ARM offers a low introductory fixed rate term, typically for 5, 7, or 10 years. After the initial period is over, the adjustable period follows for the remainder of the 30-year term. During this adjustment period the interest rates can adjust up or down, depending on the financial index it is attached to. 

Why it’s great for first-time buyers

For many individuals, this can be a great option when they are looking to purchase their first home. According to the National Association of Realtors, the average time a person stays in their home is just six years, based on data over the past two decades.

Additionally, many first-time homebuyers will choose to stay in their starter home, but will refinance within the first 3 to 7 years, giving them new rate terms.

It allows buyers to get more house

Lenders are able to offer lower interest rates on an ARM because they only have to guarantee that rate for the introductory fixed period. With a lower introductory rate, first-time buyers may be able purchase a higher priced home than they would with a 30-year fixed loan.

For example, if a buyer was looking to spend $1,500 a month on principal and interest and had 20% of the purchase price to put as a down payment, here are the different home prices they could afford, depending on the interest rate they received:

  • 3.375% interest: $425,000 purchase price
  • 4% interest: $393,750 purchase price
  • 5% interest: $350,000 purchase price

The lower introductory rate allows buyers to get in a higher priced home compared to mortgages that have higher interest rates.

adjustable rate mortgage armThe benefits of an ARM

  • Lower interest rates and payments early in the life of the loan
  • Mortgage payments and interest rates remain fixed for introductory period
  • Caps on interest limit the amount a rate can rise annually and over the life of the loan
  • Possibly qualify for a higher loan amount and afford more home
  • Pay off your principal balance faster by making additional payments each month

If you go with an ARM and don’t refinance or move in the next 5 to 7 years, you will reach the end of your ARM fixed term. When an ARM adjusts, the interest rates may be higher or lower than they are when you first get the loan.

There is a risk of your interest rate and payments adjusting up. If your ARM does adjust up, a Cap will limit the amount that the loan can go up annually and over its lifetime. You will be able to anticipate a worst-case scenario and know exactly how far up your interest rate can change that year and beyond. Keep in mind that, while the initial fixed period of an ARM benefits the borrower, the adjustable period benefits the lender. 

An ARM can be a powerful tool to get you a lower interest rate and monthly payments for a set period of time. For first-time buyers who often plan on moving or refinancing in the next 5 to 7 years, an ARM could be an ideal loan. Our loan experts at American Pacific Mortgage can help you to determine if an ARM is a fit for your financial goals.

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