Adjustable Rate Mortgage Pros and Cons

When it comes to purchasing a new home or refinancing your existing property, you are likely to be greeted with several mortgage options. And an option that most people seem to be aware of is - the fixed rate mortgage, and this is without doubt one of the most popular options when it comes to finding a suitable mortgage. However, in recent years the adjustable rate mortgage has been proving to be equally as in demand, but what are the specific pros and cons of the adjustable rate mortgage?

The first factor you should be aware of is that an adjustable rate mortgage will have an interest rate that fluctuates in accordance with current market rates. Therefore, if market rates increase, you can expect the interest rate on your mortgage to increase, thus meaning a higher monthly payment. The exact opposite is true when market rates decrease.

So why exactly has the adjustable rate mortgage become so popular? In order to answer this question we should consider the following:

Pros

  • An adjustable rate mortgage will typically have a lower initial interest rate than a fixed rate mortgage
  • This is turn means that you may be able to afford a bigger mortgage
  • As the interest rate is generally lower than a fixed rate mortgage you should find that the initial payments on an adjustable rate mortgage are lower
  • As mentioned, the interest rate and payments will automatically drop in line with market rates
  • If the adjustable interest rate does drop, this may save you from having to refinance if you are currently struggling to afford your monthly mortgage payments
  • An adjustable rate mortgage can be extremely cost effective if you are not planning to stay in your new property for any considerable length of time

Cons

  • As mentioned, your payments and interest rate can go up in line with market rates
  • Once interest rates start to increase they can quickly surpass what you may have been offered with a fixed rate mortgage
  • Borrowers often find that the first increase is typically a large one, and the annual interest rate cap may not apply in this situation
  • If your payments are constantly fluctuating it can be extremely difficult to budget accordingly
  • Eventually your mortgage loan may get to a level that you can no longer afford
  • If you find that a fixed rate mortgage is now a more viable option, you will have to pay for the additional cost of refinancing

These are the basic pros and cons of an adjustable rate mortgage, however, if you decide that this is the right type of mortgage product for you, there are a number of questions you'll want answered.

How often will the rate adjust?
This will very much depend on which lender you took your mortgage out with. An adjustable rate mortgage will typically only adjust once a year, although in some cases this may happen as often as once a month.

What is an annual cap?
An annual cap is a yearly restriction and will inform you of the maximum interest rate your mortgage can rise to in any one year. This is actually a great help in budgeting for the year ahead, and you will want to compare the annual cap's that various lenders have on offer before you select a suitable product.

What a lifetime cap?
A lifetime cap will basically let you know the highest the interest rate can rise to during the lifetime of your mortgage. Essentially, you can call this the worst case scenario.

Who determines rate fluctuations?
Your interest rate can either be tied to CD interest rates, LIBOR rates, or Treasury bills. This is something you will need to clarify with your specific lender.

What is a margin?
Your lender will generally charge you a certain percentage over the above mentioned interest rates. This is, once again, something that you will need to clarify with your lender.

As you can see an adjustable rate mortgage may be a fantastic option for you, although you do need to be aware of the many intricacies it presents. The best advice I can offer is to ensure that you are fully aware of the terms of an adjustable rate mortgage loan, and that these fall in line with your individual circumstances.