Adjustable-rate mortgages (ARMs) provide homeowners with a flexible mortgage option. While fixed-rate loans have a predetermined rate of interest, ARMs fluctuate based on market conditions and the terms of the agreement. This has several advantages and disadvantages, which we discuss below.
Before signing an ARM agreement, homeowners should consider how to plan for interest rate adjustments over the course of their loans. This brief guide clarifies how interest rates fluctuate and how homeowners in Maryland can plan for the adjustments over time.
Adjustable-Rate Mortgage vs Fixed-Rate Mortgage
A fixed-rate mortgage sets a predetermined interest rate for the loan period, determined by the initial agreement. This rate resists market changes, potentially leading to positive or negative gains for the homeowner.
Conversely, an adjustable-rate mortgage (ARM) uses an index to adjust the rate over time. The interest rate can fluctuate but changes at predetermined times based on the agreement.
For example, an ARM's initial interest rate is fixed for a set period at the start of the loan, often 5, 7, or 10 years. The lender’s terms may include a “reset” of the rate on a yearly or even monthly basis after that initial period. Yet, homeowners will know exactly how much interest they will owe on their ARM for the initial payments.
Adjustable-rate mortgages are not the best option in every situation, but the advantages of choosing an ARM include:
- Lower initial rates: The fixed initial rate allows homeowners to reallocate their savings to initial expenses such as home repairs, furniture purchases, and private loan payments.
- Potential market resilience: The fact that the interest eventually adjusts does not secure that the adjusted rate will be higher than the initial rate. If the market trends up, homeowners may make gains on both the fixed and adjusted rates.
Yet, homeowners may also endure losses in both periods using the same logic. ARMs can benefit homeowners in financially vulnerable times, but you should always be prepared for a potential market change.
Steps to Plan for Interest Rate Adjustments
Homeowners can follow these simple steps to plan for interest rate adjustments on their ARMs:
1. Reduce High-interest Debt
One of the best ways to prepare for mortgage rate adjustments is to use the initial fixed period to pay off high-interest personal loans, credit debt, or car payments. The longer these high-interest loans are active, the fewer resources you will have when your mortgage rate begins adjusting.
2. Make a Larger Down Payment
Many homeowners take advantage of the lower initial interest rate to make a larger down payment on their house. This helps them prepare for the eventual fluctuation by reducing their long-term loan amount and, thereby, their interest payments using the initial rate as a safety net.
3. Improve Credit Score
Another way homeowners can plan for mortgage rate adjustments is to improve their credit scores during the initial interest period. This can be achieved by repaying debts, paying cards off on time, reducing the number of loans, and not opening new lines of credit.
4. Refinance the Mortgage
With a better credit score, mortgage refinancing becomes a viable option. That possibility depends on your situation, including your mortgage lender's terms. However, some homeowners find that their financial situation has changed, making refinancing their ARM to a fixed-rate mortgage an advantageous option.
This is most common when homeowners are able to improve their financial situation compared to when they first signed the loan. With a better credit score or a better overall economy, you may be able to negotiate lower fixed-rate interest compared to your adjustable rate.
Note that this type of refinancing can change the length of the loan. Sometimes, this is to the homeowner’s advantage due to their better financial situation. Other times, it comes at the cost of changing the initial agreement.
Speak with your mortgage lender and a financial professional in Maryland to learn more about refinancing ARMs, planning for adjustable rates, and taking advantage of the low initial interest period.
Contact Financial Professionals to Plan for Interest Rate Adjustments on Your New Mortgage
Interest rate adjustments on 15-30-year adjustable-rate mortgages fluctuate based on market conditions and the prearranged terms of the loan agreement. Many homeowners understand the concept of ARMs and their potential short-term benefits without recognizing how to plan for future adjustments and confront the potential downsides of offloading interest to later payment periods.
Contact our experienced team at Woodsboro Bank to learn how interest rate adjustments will impact your mortgage situation. An ARM provides numerous advantages to homeowners, provided the right care and planning are considered when budgeting for adjustments over time.