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Your Personal Finance Questions - Answered!

“What is an Adjustable Rate Mortgage, and are they better than fixed mortgages?”

This is part of our daily “Ask a Financial Advisor” series.

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As a reminder, this week we are exploring topics related to buying a home. Yesterday’s episode covered the main differences between the two most common types of mortgages, a 30 and 15 year fixed rate mortgage.

Today we look at alternative mortgage types, and how to know when they are right for you.

Today’s question is:

“What is an Adjustable Rate Mortgage, and are they better than fixed mortgages?”

 

What is an Adjustable Rate Mortgage (ARM), and is it right for me? - Transcript:

When most of think about mortgages, we think about a fixed payment for the life of the mortgage. For some, this is very comforting. You know your payment for the next 30 years. That makes planning very easy.

But, adjustable rate mortgages, also known as ARMs, are different. They have the ability for the loan’s interest rate to change, up or down, during the life of the loan.

You will typically see them annotated as a 5/1 ARM, or a 7/1 ARM. Typically, the first number indicates the number of years the loan’s interest rate is fixed for, and the second number indicates the number of years between rate adjustments. So, on a 5/1 ARM the rate is fixed for 5 years, then adjusts every 1 year thereafter.

That means if interest rates rise, you may see your mortgage payment rise significantly. That means there is a little bit of risk to these types of mortgages. But they do have some benefits as well.

First, rates on ARMs are typically lower. So if you plan on living in your house for just a few years, or plan to pay off your mortgage in a short time, they can save you a lot of money.

Because the interest rates are lower, it also means you may save a significant amount of money on your mortgage if interest rates stay level or drop.

So when is an ARM right for you? If you know you will not be living in the house long, or the prospect of a rising mortgage payment doesn’t scare you, you may be able to benefit by taking a gamble with an adjustable rate mortgage.

Matt Hylland