Blog posted On August 07, 2018
All mortgage loans have either fixed-rate or adjustable-rate terms. With a fixed-rate mortgage, the interest rate will stay the same throughout the life of a loan. With an adjustable-rate mortgage, the interest rate will move up or down after a fixed period of an introductory rate that lasts three to seven years, depending on the length of loan. Typically, adjustable-rate mortgages will have an interest rate cap that they will not be able to exceed.
Some home buyers and homeowners prefer adjustable-rate mortgages because the initial interest rate is usually less than the interest rate on a fixed-rate conventional loan. However, this interest rate may increase over time, depending on greater economic circumstances, increasing the cost of the monthly mortgage payment. Adjustable-rate mortgages were popular during the construction boom of the early 2000s, and some economists believe they contributed to the housing crash when homeowners could not afford their mortgage payments. When used in the right circumstance, adjustable-rate mortgages can be a better option than conventional financing.
When is an adjustable-rate mortgage right for you?
Lower Credit Scores Accepted
Most conventional mortgage loans require a credit score of at least 680. Government-sponsored loans like FHA loans have more lenient credit standards but will have other restrictions. Home buyers may benefit from an adjustable-rate mortgage, so they can avoid paying higher interest rates because of their low credit score.
Lower Introductory Interest Rate
When average interest rates are low, adjustable-rate mortgages are not as popular. But, in a rate-rising environment, home buyers choose adjustable-rate mortgages because they have a lower introductory interest rate. On average, an adjustable-rate mortgage will have an interest rate about .5 percent lower than a conventional loan. It might make sense for some home buyers to have a lower payment at first, although they will have to prepare for a higher interest rate later.
Better for Short-Term Loans
In some circumstances, the homeowner will not have the loan long enough for the lower interest rate to expire. This is especially the case for investment properties or fixer-uppers. Before you choose an adjustable-rate mortgage for your short-term loan, make sure there is no early repayment penalty. When you sell the home or refinance into a different loan type, you could face a penalty as high as 2% or 3% of the total loan.
Lower Fraud Risk
Historically, adjustable-rate mortgages are less risky than conventional mortgages for mortgage lenders. Would-be identity thieves and scammers are less likely to go for adjustable-rate mortgages, according to Credit.com.
With additional rate hikes expected this year and next, adjustable-rate mortgages have started to become popular again. Although the interest rate with an adjustable-rate mortgage will go up over time, it typically has a lower introductory rate than a conventional loan. Adjustable-rate mortgages may also be the right choice if you are in the process of rebuilding credit or will only need the loan for a short time. The best way to determine if an adjustable-rate mortgage is right for you is to consult a mortgage loan officer. A loan officer can review your financial profile, get you prequalified, and determine what the best mortgage is for your short and long-term financial goals.