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By Thomas Muellner
Beyond the months of research, dozens of open house visits and long discussions with your realtor, one of the most important aspects of buying a new home is securing a mortgage that fits your financial needs.
But when it comes time to sign on the dotted line, how will you decide which type of mortgage is best for you?
Though common wisdom is to opt for a slow-and-steady 30-year fixed mortgage, depending on your personal situation and plans for the future, you may find greater value in an adjustable rate mortgage (ARM). After all, the sage advice mom or dad shared may not factor in all the current choices available on the market.
By knowing all of your mortgage options, you can be sure you’re making the best move for you and your family when buying your next home.
An adjustable rate mortgage is one in which the interest rate changes at predetermined intervals based on the specific loan type. The exact amount the interest rate shifts at each checkpoint is determined by a benchmarked index rate and is typically capped at both a high and low threshold.
In an ARM, borrowers have the benefit of a lower initial interest rate and smaller monthly payment at the start of their loan, knowing that payments and interest rates can change as the loan reaches its full term.
While a lot has been made over the years about potential risks of adjustable rate mortgages, in practice, they can be a safe and practical alternative to traditional 15- or 30-year plans. The federal government now regulates ARMs more stringently than they did in the past, plus most modern ARMs actually start off with a fixed rate for a period of up to 10-years. You may see these listed as “10/1 ARM,” “10/6 ARM,” “3/1 ARM,” or “3/6 ARM” loans.
The first number in the above examples indicates the number of years you’ll pay the initial fixed rate, while the second number indicates the frequency with which the rate is adjusted after that initial fixed-rate period is over. The time period between adjustments is typically one year or six months. For example, Alliant offers a 10/6 ARM that has an initial fixed term of 10 years, after which the rate is adjusted every six months.
Though specific terms vary by institution, at Alliant, borrowers can select flexible mortgage options that adjust after 3, 5, 7 or 10 years with highly competitive rates.
One of the major pros of going with an adjustable rate mortgage is that it reduces your short-term housing costs. For an average home, the switch could leave an extra $1200 or more a year in your budget to pay down the mortgage principle, invest in home renovations or dedicate toward savings.
Because of the lower initial interest rate in an ARM, monthly payments are generally lower than a traditional fixed rate mortgage. As a result, you’ll be in better shape when borrowers judge your income to mortgage payment ratio. In effect, a smaller portion of your total income needs to be dedicated to housing.
Alliant offers some of the lowest ARM rates in the country, and we love helping forward-thinking homebuyers select the loan terms that best meet their needs.
By opting for an adjustable mortgage, you’re betting on yourself in a way. That’s a good thing, so long as you’re fully prepared financially when interest rates shift.
And beyond saving extra cash on the front end, there’s an obvious advantage to having an adjustable rate: plans change.
On average, individuals only stay in their homes for about 8 years before moving. Whether you’re changing cities for a new job or upgrading your space to accommodate a growing family, if you’ve got an ARM, there’s a decent chance you’ll be on the move before the fixed period ends. And when you negotiate your next mortgage, the process will start all over again.
Should you choose to stay in your home through the duration of your mortgage term, there’s a possibility that your interest rate may decrease after you reach the 5- or 7-year mark. And even if rates increase, you’re protected from extreme rate jumps by the caps put in place when the loan initiated.
While it’s a decision that differs for all home buyers, coming to the table with an open mind is a great place to start. Too often, securing a fixed rate is conflated with locking in a good deal. Traditional 15- and 30-year fixed mortgages protect borrowers from uncertainty, but taking a conservative approach has its limitations. At the end of the day, it comes down to personal goals and the financial steps you plan to take to make your house a home.
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