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Mortgage Rates Are Up. Does a 5/1 ARM Make Sense? – The Motley Fool

Image source: Getty Images.

It may seem like a good option, but there are risks to consid…….

Image source: Getty Images.

It may seem like a good option, but there are risks to consider, too.

Key points

  • Based on today’s mortgage rates, a 5/1 ARM could save you money.
  • If you’re going to get an adjustable-rate mortgage, it’s important to recognize the downside involved.

It’s no secret that mortgage rates have risen astronomically since the start of the year. The reason for that is twofold. First, rates were so low from mid-2020 through the end of 2021 that something was apt to give. And also, the Federal Reserve has been moving forward with rate hikes in an effort to quell inflation.

Now the Fed doesn’t dictate what rates consumers are charged on a mortgage. In fact, the Fed doesn’t set any consumer borrowing rates. Rather, it oversees the federal funds rate, which is what banks charge one another for short-term borrowing. But when the Fed raises rates, consumer interest rates tend to follow suit, so borrowers are now looking at spending more money to take out a mortgage.

If you’re looking to get a mortgage, you may be interested in a 5/1 ARM. That way, you’ll lock in a lower interest on your loan for at least five years compared to what you’ll pay for a fixed-rate loan. But while an adjustable-rate mortgage might seem like a good option right about now, there’s a big drawback to consider.

There are pros and cons at play

Right now, the average 30-year mortgage rate is 5.449%. Meanwhile, the average 5/1 ARM rate is 4.547%. At a difference of roughly 1 percentage point, a 5/1 ARM could result in significant savings — at least initially.

But when you sign a 5/1 ARM, you’re only guaranteed your initial interest rate for the first five years. Once that period expires, your loan’s interest rate could adjust once a year.

Now here’s the tricky thing. When you sign an adjustable-rate mortgage, there’s a chance your rate could drop over time rather than rise. But you’ll need to be prepared for the opposite to happen, and for your mortgage to get more expensive over time.

Is a 5/1 ARM right for you?

If you’re buying a starter home, then a 5/1 ARM could actually be a good choice. There are no rules as to how long you stay in a starter home — it’s up to you. But if you’re buying a starter home, …….


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