Is an ARM loan risky?
The way most adjustable loans work these days is that they're fixed for either five, seven, or 10 years and then they adjust to wherever rates are in the market. So they definitely come with more risk than fixed rate loans. But for some homebuyers, Lewis says that can be a risk worth taking.
ARMs require borrowers to plan for when the interest rate starts changing and monthly payments grow. Even with careful planning, though, you might be unable to sell or refinance when you want to. If you can't make the payments after the fixed-rate phase of the loan, you could lose the home.
Key takeaways. Adjustable-rate mortgages (ARMs) have gained popularity as interest rates have risen. ARMs carry slightly lower rates than fixed-rate mortgages. If you expect rates to fall, or plan to move before the initial fixed-rate period expires, getting an ARM can make sense.
With the current interest rates pushing many buyers out of the market, using an ARM can bring them back in the game. Here are some reasons for getting an ARM in 2023: ARMs often offer interest rates and entire point lower than the current 30-year fixed rate mortgages.
Types of high-risk loans
Secured loans: These loans require you to put up an asset, such as your car or house, as collateral to secure the loan. If you stop making payments or default, you can lose that collateral. The value of the collateral can vary widely, depending on the loan amount.
Monthly payments might increase: The biggest disadvantage of an ARM is the likelihood of your rate going up. If rates have risen since you took out the loan, your payments will increase when the loan resets.
An ARM can make sense if you don't plan to be in the home long enough to see the first rate adjustment, such as if you plan to move again within the next 5 years. But even if you go this route, beware that if your initial timetable doesn't pan out, you could face higher payments when the rate begins to adjust.”
An ARM can be a great idea considering the initial lower interest rates, but it's not the best fit for all homeowners. For one, you need to be comfortable with the risk that your mortgage payments could go up after the initial fixed-rate period is over.
If you move in several years, an ARM could save you money. You'd benefit from the low introductory fixed rate, then sell the home before the adjustable period starts. You plan to pay off the mortgage quickly. Say, for instance, you expect a financial windfall, such as an inheritance.
7/1 ARMs can be a good option for those planning to sell their home or refinance within the first seven years, but may not be suitable for those planning to stay in their home for the long term or who are not prepared for potential rate increases.
Can you refinance an ARM loan?
You can refinance an adjustable-rate mortgage, and it's just as easy as refinancing any other loan. By refinancing, the borrower is replacing their existing loan with a new, updated loan – usually a fixed-rate mortgage.
ARMs are easier to qualify for than fixed-rate loans, but you can get 30-year loan terms for both. An ARM might be better for you if you plan on staying in your home for a short period of time, interest rates are high or you want to use the savings in interest rate to pay down the principal on your loan.
For a 7/6 ARM, the introductory period is 7 years, and then once that expires, the interest rate can adjust every 6 months. Keep in mind, not all ARM loans may adjust downward even if market movement would indicate it should do so.
- What Makes a Mortgage Risky?
- 40-Year Fixed-Rate Mortgages.
- Adjustable-Rate Mortgages (ARMs)
- Interest-Only Mortgages.
- Interest-Only ARMs.
- Low Down Payment Loans.
- The Bottom Line.
- Payday loans. Payday loans are the worst type of loan to get, because they offer very high interest rates and short repayment terms. ...
- Title loans. Title loans are another high-interest loan to avoid due to its high fees and requirement of using your own car for collateral. ...
- Cash advances. ...
- Family loans.
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
ARMs become especially appealing when general interest rates rise. This is because ARMs generally have interest rates significantly lower than those available for fixed-rate loans. Lower interest rates mean lower monthly payments for you. When your fixed-rate period ends, your rates will be adjusted.
As a result, roughly 10% of all mortgages are now ARMs. Take a look at the big spike below as the mortgage market “reARMs” with mortgage rates higher since 1Q 2022. Mortgage rates are finally falling in 2024 as the Fed is anticipated to cut rates multiple times now that inflation has rolled over.
An ARM may make good financial sense if you only plan to live in your house for that amount of time or plan to pay off your mortgage early, before interest rates can rise. An ARM may also make sense if you expect to make more income in the future.
Your loan type: Because adjustable-rate mortgages (ARMs) carry a higher risk for lenders, your PMI might be more expensive with an ARM than it might be with a fixed-rate mortgage loan. Your down payment amount: A down payment of 20 percent or more results in no PMI.
What are the dangers of an ARM vs fixed?
Is an ARM riskier than a fixed-rate mortgage? Yes. An ARM comes with a greater risk of a higher monthly payment if rates are higher in the future.
With an ARM, borrowers lock in an interest rate, usually a low one, for a set period of time. When that time frame ends, the mortgage interest rate resets to the prevailing interest rate. ARMs may be attractive to borrowers because the initial interest rate is low.
| Product | Interest Rate | APR |
|---|---|---|
| 3/1 ARM | 6.14% | 7.64% |
| 5/1 ARM | 6.15% | 7.33% |
| 7/1 ARM | 6.27% | 7.25% |
| 10/1 ARM | 6.95% | 7.80% |
Down payments for ARMs are usually the same as fixed-rate loans, but loan types allow for lower down payments (FHA or VA loans). In most cases, expect a minimum of 5% down, though 20% is preferred because private mortgage insurance (PMI) is often required on loans with less than a 20% down payment.
7- and 10-year ARMs may only increase by two percentage points annually after the initial fixed interest rate period, and six percentage points over the life of the Mortgage.
