When you purchase a home or refinance the loan on your current home, you may consider a variable-rate mortgage. While this type of mortgage isn’t as popular as a fixed-rate mortgage, it could be a good way for you to lower costs — in the right situation.
Variable-rate mortgages, also known as adjustable-rate mortgages (ARM), offer an interest rate that changes throughout the life of the loan. Most ARMs offer a fixed interest rate for the first five years.
Then, the interest rate could change based on an annual assessment conducted by your mortgage company. Your interest rate could go up or down based upon market conditions.
Commercial real estate investor Michael Eisenga cautions that variable-rate mortgages aren’t for everyone. Used in the right context, though, they could be beneficial to some. Here are some things to consider.
How Long Will You Own the Home?
Is the home you’re purchasing your forever home, or is it a starter home you plan to move out of in the next few years?
One of the biggest advantages of an ARM is the lower interest rate that it provides upfront. The typical ARM will offer an initial interest rate that’s a quarter of a percentage point lower than that of a fixed-rate mortgage.
If you plan on selling your home within five years, then you won’t even take on the risk ARMs provide — the adjustable rate.
Can You Afford the Volatility?
If you plan on staying in your home beyond five years, then you need to consider whether you can handle the potential volatility of an ARM. When the interest rate on your mortgage increases, so, too, will your monthly payment.
If you have the financial flexibility to afford what could be sometimes large interest rate increases, then you’ll be okay. If you’re living close to your means, then an ARM might not be for you.
Are Interest Rates Likely to Rise or Fall?
With mortgage interest rates at historical lows over the last few years, it’s hard to predict that they’ll do anything but rise. The key, though, is how high they are likely to rise over the life of your loan.
If interest rates have been on a downward trend for the last five years and are likely to keep decreasing, then an ARM could prove very beneficial. If it’s more likely that interest rates will steadily increase, then a fixed-rate mortgage is probably better.
Will an ARM Get You into a Home?
Another aspect you should consider is whether an ARM will make it affordable for you to own a home today versus the terms of a fixed-rate mortgage. If an ARM gets you into a home today, then it could be a good option.
Michael Eisenga says an ARM could be particularly beneficial to people whose financial situations are likely to improve in the coming years. Younger homeowners and newer families fall into this category.
If an ARM allows you to start gaining equity in a home now, and a fixed-rate mortgage would prevent you from doing so, then it could be a good option. As your financial situation improves, you’ll likely be able to sustain changes in your interest rate better down the line.
Plus, if your interest rate climbs too much on your ARM, then you can always consider refinancing to a fixed-rate mortgage later.
About Mike Eisenga
Michael Eisenga is a successful commercial real estate investor with a banking and finance background and is the former mayor of the City of Columbus. As a President of both American Lending Solutions, a mortgage lending company (he founded and operated from 2000 to 2018), and First American Properties, he has a track record of creating and operating successful businesses. Mr. Eisenga is also devoted to property development and construction, primarily serving smaller local communities. Especially in the senior housing sector.