Adjustable Rate Mortgage

Advantages & Disadvantages of an Adjustable Rate Mortgage?

Last Updated 12/11/2014

Adjustable rate mortgages have a bit of a mixed reputation. These are mortgages with monthly payments that can change based on the market interest rate. This feature makes an adjustable mortgage loan a bit riskier than a fixed rate loan but can also potentially make these loans more affordable. It’s important to understand both the advantages and disadvantages of an adjustable rate mortgage so you can decide whether this product is right for you.

Advantage 1 – Lower Payments at the Beginning 

When you first sign up for an adjustable rate mortgage, your monthly payments will be lower than a fixed mortgage loan for the same amount of money. That’s because lenders are taking on less of a risk by giving you an adjustable rate. If interest rates go up during your mortgage, lenders will get a chance to increase your monthly payments. If you’ve found your dream home but can’t afford the fixed rate mortgage payments, an adjustable rate loan could be the way to buy now.

Disadvantage 1 – Chance of Higher Payments in the Future

The monthly payments on an adjustable rate mortgage change over time. Chances are, in the future you’re going to have months where you’ll be paying more per month than at the start of your loan. This is particularly true now because interest rates are at historical lows. There’s almost nowhere for payments to but up on an adjustable rate mortgage. This is something you need to prepare for so you don’t get caught off guard.

Advantage 2 – Payments Can Go Down

The adjustment on an adjustable rate mortgage works both ways. If interest rates go down, your monthly mortgage payments will go down as well. If you’re buying a house at a time when mortgage interest rates are high, an adjustable mortgage loan could be a good idea. You won’t be locking yourself into the higher payments and when rates eventually go down, your mortgage will become more affordable.

Disadvantage 2 – Uncertainty for Budgeting

With an adjustable rate mortgage, your payments will change on a regular basis. Some loans adjust your payment every month. Others change your monthly payments only once a year or every several years. All situations make it a little difficult to budget. Since you can’t know exactly what your mortgage payment is going to be, you need to be more careful. You should keep extra money in savings, especially when you payments are low, to prepare for when the mortgage payments go up.

Advantage 3 – Less Expensive for Shorter Loans

Adjustable rate mortgages are a good choice for shorter mortgages, when you plan on keeping the loan for less than ten years. This could be because you plan on paying off the loan quickly, moving within a short timeframe, or refinancing during this time. The reason this works well is because you’ll benefit from the lower payments at the start of the adjustable rate mortgage and then will end the loan before facing the potentially higher payments later on.

Disadvantage 3 – Could Be More Expensive for Longer Loans

On the other hand, adjustable rate mortgages can become more expensive if you plan on staying in a house for more than ten years. Your mortgage payments will have more time to adjust upward making your loan significantly more expensive than a fixed rate mortgage. This puts you in a tough situation where you either have to risk significantly higher payments or pay for a refinance to a fixed rate mortgage, which can cost thousands of dollars.

By understanding these points, you should be able to decide whether an adjustable rate mortgage makes sense or you’d rather go with a fixed rate mortgage.