Rising interest rates are making adjustable-rate mortgages an increasingly attractive alternative to common 30-year, fixed-rate home loans.
As interest rates on traditional fixed-rate 30-year mortgages climb higher and higher, an increasing number of buyers are turning to adjustable-rate mortgages in hopes of getting a better deal.
But while the potentially lower rates these mortgages can offer may seem appealing at first glance, buyers need to take the time to do the calculations to make sure it’s a smart decision for the long term.
A traditional mortgage locks in an interest rate for 15 to 30 years, depending on the loan. While buyers were enjoying years of historically-low rates during the COVID-19 pandemic, fixed rates have been soaring in recent weeks, with the average 30-year hitting 5.25% last week, according to Freddie Mac. At the start of the year, the average was around 3.4%.
Rising mortgage rates, in conjunction with sharply higher home prices, make homeownership less affordable.
“It’s natural for homebuyers to be looking at ways to reduce that mortgage payment, and one of the ways is to use an adjustable-rate mortgage,” said Selma Hepp, deputy chief economist at CoreLogic.
Adjustable-rate mortgages don’t make it any easier to qualify for financing, but they do offer buyers some flexibility with their monthly mortgage payments in the first few years of the loan term.
Fixed-rate vs. adjustable-rate mortgages
A key difference between an ARM and a fixed-rate mortgage is the interest rate. An ARM typically has a lower initial interest rate than a fixed-rate loan. That means the monthly payment during the introductory period of an ARM is lower than the payment of a fixed-rate mortgage.
After the ARM’s initial rate period, however, the rate and monthly payment can rise. Although there’s a limit to how much your rate can increase, it can still climb considerably, and you could wind up with an unaffordable monthly payment after the first few years of your loan term.
A fixed-rate mortgage, by contrast, has a fixed payment throughout the life of the loan, and the rate and payment won’t change unless you refinance to a different loan.
One other point of differentiation: ARMs generally require a slightly higher down payment of 5 percent. For a fixed-rate conventional loan, you can put down just 3 percent.