The pros and cons of adjustable-rate mortgages
November 13, 2010 - Before perspective homebuyers take advantage of low home prices and federal tax credits for homebuyers, it is important that they educate themselves on the types of mortgages on the market.
The most common type of mortgage is the 30-year fixed rate mortgage, which means that the interest rate is locked-in during the 30 year span of the loan.
Another type of mortgage is the adjustable-rate mortgage (ARM). As its name suggests, the interest rate changes periodically on the loan, usually in relation to an index, causing mortgage payments to go higher or lower. The interest rate and monthly payment changes every month, quarter, year, three years or five years. A 5-year ARM has a five-year adjustment period, or time between rate changes.
According to the Federal Reserve Board (FRB), one of the advantages of an ARM over a fixed-rate mortgage is that the initial interest rate tends to be lower. Secondly, over the long term, ARMs can be less expensive than a fixed-rate mortgage if interest rates remain steady or fall.
There are disadvantages to these mortgages, however. The FRB cautions that there is more risk associated with ARMs because, should interest rates increase, the homeowner's mortgage payments will also increase. It is also possible for monthly payments to change; they could go up even if interest rates don't change. Additionally, there may be a penalty for paying off the mortgage early.
Freddie Mac reports that for the week ending November 12, 30-year fixed rate mortgages decreased to 4.91 percent down from 4.98 percent the previous week. In comparison, the 5-year ARM averaged 4.29 this week, down from 4.35 last week.
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