Pros And Cons Of Adjustable Rate Loans

Is an adjustable rate loan right for you? A few things to consider when choosing the best loan options.

It doesn't take a rocket scientist to figure out that the majority of people in our society are interested in saving money. Department stores boast "lowest prices of the season" sales nearly every weekend. Half of Sunday's newspaper consists of sales fliers or coupons to clip. And whose mailbox isn't full of money saving opportunities nearly every day? We clip coupons, mail in rebates, and check the online auctions all in hopes of saving money whenever possible. And, this same money-saving mindset is at the forefront of our home-buying ventures as well. We select a price range that our budget will be able to accommodate, search for the most affordable option to fit our lifestyle, and hope to purchase the home for a little less than the asking price. After going to all of this effort to get the biggest bargain, it only makes sense that we would want to choose the home mortgage that will offer the best bargain as well. And, as many potential home buyers quickly discover, adjustable rate mortgages often offer the lowest interest rate available. However, it is important to carefully consider the pros and cons of such a loan prior to signing on the dotted line.

One of the biggest, and most obvious, advantages of an adjustable rate mortgage is the fact that the lowest interest rates are generally associated with such loans. In fact, the interest rate on adjustable rate mortgages can be significantly more desirable. And, simply put, a lower interest rate equates to a lower mortgage payment each month. Not only does this save the homeowner money with each monthly payment, it will offer a significant savings over the life of the loan. This savings often means the difference between being able to afford a new home, and being able to afford the home of your dreams.

Let's consider the difference a lower interest rate can make. If we were to take out a 30-year mortgage for $200,000 at 5% interest, the monthly payments on principal and interest only would be approximately $1074. Over the life of the loan, we would repay a total of $186,513 in interest alone. If we were to borrow the same $200,000 for 30 years at 7.5% interest, our monthly payments on principal and interest only would be $1398. That's an increase of $325 each month, simply due to a higher interest rate. Over the 30-year life of the loan, we would repay $303,434 in interest alone. The higher interest rate would cost us an extra $116,921 over the life of the loan. There's no doubt about it, a lower interest rate is important.

So, if an adjustable rate mortgage offers a lower interest rate, then why isn't this the best option for everyone? Because all good things must come to an end. Adjustable rate mortgages fluctuate, and the lower rate may not last forever. Accepting the terms of such a mortgage means you are willing to take the risk of the interest rate increasing significantly while you own your home. The interest rates on an adjustable mortgage will increase or decrease based on the economy. And, in time, what began as a very low, desirable rate, may become significantly higher than the fixed rate you were able to obtain at the time the home was purchased. If your budget is not able to accommodate an increased interest rate and higher payments, an adjustable mortgage might not be the best option. A fixed rate mortgage may start out a few points higher, but you are guaranteed that rate will remain constant throughout the life of the loan.

There are definitely options available. For instance, you might choose to take advantage of an adjustable rate mortgage's lower interest rates at the time the home is purchased, with the intention of refinancing and obtaining a fixed mortgage if the rates begin to rise. Or, you might determine that the initial rate is desirable enough that you could afford the increased interest when and if the rates begin to climb. Often there will be a cap on how much the interest rate is able to increase, and how often the rates can change. Be sure to find out all of this information before making a decision on which loan will best suit your needs.

Another consideration is the fact that adjustable mortgages usually offer a certain period of time during which the low rate is locked in. Each loan will offer different terms, and it is imperative that you find this information. Assuming that this period during which the rate is locked-in is five years, and you do not plan to own the home that long, you will not have to deal with an increased interest rate. You will be selling the home before the increased interest rate impacts you financially.

In other situations, homeowners may anticipate that their income will increase enough during this locked-in period that they will be able to afford a potentially higher interest rate, the initial savings may be well worth the risk. For example, homeowners at the beginning of their careers, completing advanced degrees, or anticipating promotions can expect that their incomes five years from now will be able to handle an increase in their mortgage payment if the interest rates rise. Those preparing for retirement, getting ready to begin a family, or expecting their children to enter college within the next few years might not be willing to take this gamble.

There are obviously many pros and cons associated with adjustable rate mortgages. Each potential homeowner must carefully consider his unique situation and determine whether and adjustable rate is right for him.

Trending Now

© High Speed Ventures 2011