Adjustable-rate mortgages are home loans with an interest rate that changes over time. This type of home loan can be risky, but with a lower initial interest rate than fixed-rate mortgages, 5/1 ARMs can be a good option – especially if you plan to sell or refinance within a few years, before the lower interest rate adjusts.
In the current rate environment, some prospective homebuyers may be considering an ARM as an alternative to a traditional fixed-rate mortgage. For the first time since 2002, rates have risen past 7% for a 30-year fixed mortgage, and data from the Mortgage Bankers Association shows that ARM demand is the highest it’s been since 2008 – with about 13% of applicants choosing adjustable-rate mortgages as of October 2022.
That being said, there are a few things you should know about using an ARM to finance your home purchase. This guide can help you understand adjustable-rate mortgages and find the right lender for your homebuying needs.
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Homefinity launched in 2018 as the online lending division of Fairway Independent Mortgage. It offers a variety of mortgage products, including conventional mortgages, Federal Housing Administration and Veterans Affairs mortgages, and mortgage refinancing.
Caliber Home Loans of Coppell, Texas, offers mortgage products nationwide. Options include conventional, adjustable-rate, jumbo, refinancing, Federal Housing Administration, U.S. Department of Agriculture and Department of Veterans Affairs loans. Caliber has been in business since 2008, and is solely focused on home lending products.
Carrington Mortgage Services, founded in 2007, offers an array of mortgage and refinancing options to borrowers seeking conventional or government-backed loans. Its California-based parent company, Carrington Holding Co., was established in 2003 and provides a range of real estate services. Carrington Mortgage Services is based in California and also has offices in Arizona, Connecticut, Florida, Indiana and Maryland.
Pentagon Federal Credit Union, widely known as PenFed, offers borrowers access to many types of mortgages: conventional, adjustable rate, jumbo and Department of Veterans Affairs, plus refinancing loans and home equity lines of credit. The financial institution, which serves 2.5 million members, was established in 1935 and is based in McLean, Virginia.
North American Savings Bank, or NASB, is a Missouri-based bank and lender founded in 1927 that offers home mortgages nationally. NASB provides a variety of mortgage options, including conventional, Federal Housing Administration and Department of Veterans Affairs loans, and products for borrowers who might otherwise have trouble getting a mortgage.
Headquartered in Charlotte, North Carolina, Truist Bank was formed in 2019 after SunTrust and BB&T banks merged. Truist Bank offers a variety of mortgage products, including refinancing and home equity lines of credit.
Chase, one of the world’s largest banks, was founded in 1799 in New York and offers mortgage and refinance loans.
AmeriSave Mortgage Corp. is an online lender that has been in business since 2002. It was one of the first to offer an offsite digital mortgage experience for customers. The company says it has financed more than 664,000 borrowers since it began operating. With headquarters in Atlanta, AmeriSave services loans in 49 states and Washington, D.C.
Simmons Bank was founded in Arkansas in 1903 and can now be found across six states. It offers mortgage products such as conventional and jumbo loans, federal-government-backed loans and state-approved down payment assistance programs.
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An adjustable-rate mortgage is a home loan with an interest rate that changes over time. Unlike with a fixed-rate mortgage, which keeps the same interest rate for the life of the loan, your interest rate will change according to a benchmark rate. Typical loan terms are 15 and 30 years, but 10- and 20-year terms are also common.
The three most common types of ARMs are hybrid, interest-only and payment-option.
- A hybrid ARM is the most common type of adjustable-rate mortgage. It has an initial interest rate that remains fixed for a certain amount of time and then adjusts periodically afterward. So a 5/1 adjustable-rate mortgage has one rate for the first five years and, after that, adjusts every year. A 3/1, 7/1 or 10/1 ARM works the same way, adjusting annually after the initial fixed-rate period (three, seven or 10 years, respectively). However, if the second number is six, such as a 7/6, your rate may adjust every six months after the initial fixed period.
- An interest-only ARM only requires interest payments during the initial payment period. After that, the loan is amortized based on the remaining term, and the monthly payment increases substantially.
- A payment-option ARM allows the borrower to choose from multiple payment options. Usually, the options are standard principal and interest payment; interest-only payment; and limited payment. In the latter, the loan balance increases if you make only required payments.
Pros
- Start with lower rates. ARMs typically start with lower interest rates than fixed-rate mortgages.
- Possible to pay less in the future. If you’re buying a home while mortgage interest rates are high, an adjustable-rate mortgage may be preferable – because if market rates go down in the future, your mortgage rate will go down, too.
- Good for short-term purchases. If you’re only planning to keep your property or mortgage for a short period, an ARM provides lower payments for that duration.
- Fixed-rate conversion is possible. Convertible adjustable-rate mortgages allow you to have lower initial payments than a fixed-rate mortgage, while also allowing you to lock in a fixed rate after a period of time.
Cons
- Rates can increase. With an ARM, your mortgage rate may increase if the market rate increases – which could end up costing you more in the long run.
- Agreements and conditions can be complex. Adjustable-rate mortgages tend to have more conditions and complex agreements than fixed-rate mortgages, which can be riskier for borrowers.
An adjustable-rate mortgage is like any other mortgage: A lender pays a seller for the home you want to buy, and you make regular monthly mortgage payments to the lender until the loan is paid off. But unlike with a traditional fixed-rate mortgage, the interest rate changes periodically, per the terms in the loan contract.
Most adjustable-rate mortgages start with a competitive initial fixed-rate period, often with a lower interest rate than what’s available on fixed-rate mortgages. When the period ends, the interest rate changes at predetermined intervals, according to the benchmark rate the loan follows.
Your interest rate changes when your adjustment period ends. The lender can raise your rate if its fully indexed rate is higher than your current mortgage rate. If the benchmark rate goes down, the lender might lower its fully indexed rate and, accordingly, your rate.
Rate caps put a boundary on how much your interest rate can change. Caps can be periodic, which limits how much the rate can increase at each readjustment period. There is also a lifetime cap, which nearly all ARMs are required to have.
It’s important that borrowers examine their individual situations and decide whether or not an ARM is the best fit.
ARMS Can Be a Great Choice
An adjustable-rate mortgage offers a competitively low interest rate for those who can avoid or minimize the impact of a potentially rising rate in the future.
If you plan to sell the property or refinance before the first adjustment period or before future interest charges outweigh early interest savings, you could save money.
An ARM also can be a good option for first-time homebuyers who expect an income boost in a few years. For example, a military family on limited deployment or a medical student who will become a doctor might be a candidate for an ARM.
ARM Loans Are Not for Everyone
However, an ARM is not the best choice for every borrower because of the potential for rate increases over time. ARMs can be complex and terms can be difficult to understand, so borrowers should be fully familiar with their benefits and drawbacks before moving forward.
You may be surprised at how much the payment can increase in the future or at the challenges you could face in selling or refinancing the property. There are several ways to achieve negative amortization on an ARM, resulting in a loan balance larger than what you originally borrowed.
One selling point of ARMs is that, technically, the rate could go down. But because an ARM tends to start low, increases are typically inevitable.
Find the Mortgage That’s Right for You
The four key factors for choosing the best adjustable-rate mortgage lender are:
Product offerings. The best lender will offer products with the terms and features that meet your needs, whether that be conventional, FHA or VA loans.
Interest rates. A low interest rate can save you tens of thousands of dollars over the life of your loan. Even a fraction of a percent can drive significant savings – or costs.
You might want to discuss the pros and cons of various ARM options with the lender, including:
- 5/1 ARMs.
- 7/1 ARMs.
- 10/1 ARMs.
- Interest-only ARMs.
Closing costs. Lenders have some flexibility when it comes to many closing costs. Generally, lower upfront costs are associated with higher interest rates. If you are looking for a loan with as little out-of-pocket cost as possible, you may face higher costs overall and vice versa.
Customer service. As with any major purchase, find out what other customers say. You may be tied to this lender for years or decades, so choose one that has demonstrated an ability to provide good customer service.
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Veterans United Home Loans offers mortgages in all 50 states and Washington, D.C., and specializes in Department of Veterans Affairs loans. Since 2016, Veterans United Home Loans has generated the largest number of VA purchase loans per year in the nation. The lender was founded in 2002 and is based in Columbia, Missouri.
PNC Bank is one of the largest banks in the United States, serving more than 9 million customers in all 50 states. A full-service mortgage lender, PNC offers most mortgage loan product types.
PrimeLending is a Dallas-based mortgage lender in operation since 1986. The company offers several mortgage loan options, including conventional loans, jumbo loans, government-backed loans and refinance loans. The lender is a subsidiary of PlainsCapital Bank.
Real Genius is a division of FirstBank, a publicly traded bank based in Nashville, Tennessee. Real Genius, formerly known as ConsumerDirect Mortgage, offers both home purchase and refinance loans.
New American Funding is a mortgage lender offering a variety of home loan options to homebuyers and homeowners nationwide except for Hawaii. The company, founded in 2003 and based in Tustin, California, has originated $61.9 billion in mortgages to date.
Guild Mortgage is a San Diego-based lender established in 1960 and focused on residential home loans. Guild Mortgage offers buyers in 43 states a full suite of mortgage products, including conventional loans, government-backed mortgages and jumbo loans.
CMG Financial is a privately held mortgage banking firm operating nationwide with localized support, founded in 1993 and based in San Ramon, California. The lender offers a range of products, including conventional, government and specialty mortgages, like jumbo loans.
LoanDepot is a mortgage lender that operates nationally with more than 200 branches and delivers both a digital experience and face-to-face service. The lender offers fixed- and adjustable-rate conventional mortgages, Federal Housing Administration and Department of Veterans Affairs loans, as well as refinance and renovation loans. The company was founded in 2010 and is based in Foothill Ranch, California.
Alliant Credit Union is a not-for-profit financial cooperative that serves customers in all 50 states. Alliant offers products such as conventional, jumbo, refinancing and home equity line of credit loans, but specific mortgage products may not be available in certain states.
Rocket Mortgage, the largest mortgage lender in the nation, was founded in 1985. The Detroit-based company is best known for its fully digital experience of buying or refinancing a home. Rocket Mortgage changed its name from Quicken Loans in the summer of 2021.
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