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Even though mortgage rates have been creeping up in recent weeks, they’re still near historic lows.
Yet that may not be enough to keep homebuyers from worrying about rising costs. The recent announcement from the Federal Reserve with plans to raise interest rates next year might make you wary of taking out an adjustable rate mortgage (ARM), even if it comes with low interest at first (also known as a teaser loan).
“Rates have been trending up a bit, and there’s speculation that we will see higher rates in the next few years,” says Kevin Parker, vice president of field mortgage lending at Navy Federal Credit Union. “Even though rates are likely to rise, there are still some situations where an ARM might make sense.”
Adjustable-rate mortgages, even in today’s conditions, do have perks. Short-term homeowners, for instance, could stand to benefit from an ARM, along with anyone who plans on paying their mortgage off faster than the standard 30-year period.
But adjustable rate mortgages come with risks. Before deciding, consider your situation, including how long you plan on living in your home and whether it’s a primary residence or rental property. Ahead, we review when an ARM might be a smart move and when it’s not.
What Is an Adjustable-Rate Mortgage (ARM)?
An adjustable-rate mortgage — usually called an ARM — is where the interest rate changes over time. On the other hand, a fixed-rate mortgage has a single interest rate for the entire life of the loan.
“An ARM can go up or down,” says Tabitha Mazzara, director of operations at mortgage lender MBanc. “From the current rates, though, an ARM really has nowhere to go but up.”
Most ARMs have a fixed period in addition to an adjustable period, Mazzara explains. For example, you might see a 5/1 ARM. In this arrangement, you have a set interest rate for the first five years of the mortgage, and the interest rate changes once per year after that.
ARM rates are often based on what’s happening in the markets and are influenced by a specific benchmark that reflects current market conditions, says Parker. Lenders usually calculate mortgage rates as whatever the federal benchmark is, determined by the Federal Reserve, plus whatever margin they adjust rates by on that given day or week.