Federal Reserve raised the federal funds rate in the United States again today in an attempt to quell rising inflation. While the Fed does not have direct control over mortgage rates, they often rise when the federal funds rate also heads north.
As of the time of this writing, the average 30-year fixed mortgage rate is 6.569 percent, the highest it has been since June of 2007 according to Freddie Mac. When mortgage rates rise as quickly as they have, borrowers who qualified for a mortgage a few months ago (3.45 percent in January 2022) now qualify for significantly less home than they were originally approved.
However, just because rates rise doesn’t mean borrowers still can’t purchase the home they have their sights set on.
There are multiple types of mortgages that can help a borrower secure financing other than a fixed rate mortgage. In this article, we will explore a creative option borrowers can utilize to get the home they want: adjustable-rate mortgages.
What Are Adjustable-Rate Mortgages?
Adjustable-rate mortgages are like fixed rate mortgages in that they have a fixed rate for a set period of time and are typically 30-year terms. However, after that set period has elapsed the interest rate will fluctuate at a predetermined interval.
Lenders usually offer 10/6, 7/6 and 5/6 ARMs. The first number represents the number of years that the interest rate will remain fixed. The second number is how often the rate will change expressed in months or years. In these examples, the rates are adjusting every six months.
The attractive feature of ARMs that attract most borrowers is its initial lower interest rate. Typically, ARMs are about half a percent lower than the average 30-year rate.
The average rate for a 10/6 ARM is 6.064 percent, 5.717 percent for a 7/6 ARM and 5.637 percent for a 5/6 ARM.
Pros to ARMs
These loans can help those get into the home they want when rates have risen drastically. They are also safe for borrowers who know they won’t stay in a particular home for more than the fixed interest rate period. ARMs are especially popular for military members, contract workers and investors.
The initial payments on ARMs can also save a significant amount of interest on a mortgage. If rates fall below their current interest rate, borrower can refinance the loan to take advantage of more interest savings.
Cons to ARMs
The obvious threat to an ARM is the payment after the interest rate adjusts. The shorter the fixed rate period, the more risk a borrower assumes when choosing this type of mortgage. Payments can become unaffordable if the market rises too quickly during the adjustment periods.
However, your rate will not jump up or double in one adjustment as most adjustment periods have a cap of one percent. The loan will also feature a lifetime cap meaning your interest rate can never go above the determined cap figure.
If home values drop, it can prevent a homeowner from refinancing the home thus leaving them to pay a higher interest rate after adjustments.
Who Are ARMs Meant For?
ARMs are best for those borrowers who are okay with assuming more risk in exchange for a lower monthly payment. This can be the difference in qualifying for mortgage or not depending on the borrowers’ debt-to-income ratio.
ARMs are also geared toward those who move around a lot or investors who like to live in the homes they fix before either selling or renting them.
Each borrower’s financial situation is different and it is highly recommended that consumers consult a financial advisor to determine if an ARM is right for them.