If you’re planning to buy a home and the idea of an adjustable rate mortgage doesn’t scare you, you may be a good candidate for an adjustable rate home loan. Although subprime mortgages are popular, ARMs can be a smart financing choice for people who intend to rent or flip the property they are buying, or who know they will be moving before the ARM’s term ends and renovation periods begin.
Read on and we’ll explain what’s involved with an ARM, explore when you might want to consider an ARM instead of a fixed-rate mortgage, and look at ARM rates from a few top lenders.
You can see a report of ARM rates for the previous trading day here.
Average mortgage ARM rates
Fortune reviewed the latest data available as of March 30. These are sample values provided by institutions. Each is based on certain assumptions about the borrower’s credit status and location. Estimates may include the assumption of mortgage discount points. If you choose to apply, be aware that the rate you receive may vary based on the sample rates shown here.
A 7/6 ARM is one with a fixed rate for seven years, then adjustment periods every six months.
Fixed rate versus variable rate mortgages
About 92% of households with mortgages choose to get fixed home loans. Unlike adjustable-rate mortgages (ARMs), which have interest rates that can change after an initial fixed term, fixed-rate mortgages keep the same interest rate throughout the term of the loan. It’s no wonder that this stability makes them a popular choice.
However, ARMs can be useful in certain situations. In fact, you may find yourself among the 8% of mortgage holders who see this type of loan as an opportunity.
If you are considering an adjustable rate mortgage
Here are three groups of homebuyers that can benefit from considering an ARM:
- First-time/first-time home buyers: If you hope you won’t stay in your home for long, an ARM can be a strategic choice. Perhaps you can enjoy a low fixed rate and sell the property before the correction phase begins.
- Real estate investors: ARMs appeal to investors for the same reasons as the point above. These buyers can keep a low initial rate, then sell the property before the adjustment period begins or adjust the monthly rent if the rate increases.
- Buyers in times of high interest: Consumers can turn to ARMs when rates are high, as these loans can sometimes offer lower rates and may even be reduced later if economic conditions improve.
How adjustable rate loans work
ARMs start with a fixed interest rate for a set period of time—usually three, five, seven or 10 years—before moving into an adjustment period. During the transition phase, several factors influence rate changes. These include:
- Benchmark rates: Many ARMs base their rates on benchmarks such as the Secured Overnight Financing Rate (SOFR), which reflects the cost that banks face for lending money. The US Treasury publishes a new SOFR daily.
- Margins: Lenders add a fixed rate to the benchmark rate to calculate your ARM’s interest rate. Interest rates typically range from 2% to 3.5%, but of course will vary based on factors such as credit, credit, and your eligibility.
- Standard estimates: Caps limit how much your rate can increase at certain times or over the life of the loan. These include first transition caps, subsequent caps, and lifetime caps.
It is common for ARMs to have a term of 30 years. Common ARM structures include the 5/1 ARM (fixed five years, then annual adjustments) and the 10/6 ARM (10 years fixed, then adjustments every six months). There are also structures like 3/1 ARMs, 7/1 ARMs and 10/1 ARMs.
Learn more: Why the Secured Overnight Financing Rate can be important to your credit score.
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Refinancing from an ARM to a fixed rate loan
If circumstances change after you take out an ARM, such as you decide you’ll be living in the home longer than you expected, it may be better for you to pay off a fixed rate loan.
For example, many Millennial and Gen Z homeowners are unable to upgrade and are continuing with their starter homes. So, know that you are not alone in crunching the numbers and knowing what the smart move is until the market improves.
The process of refinancing from an ARM to a fixed rate loan is very similar to refinancing from a fixed rate loan to another fixed rate loan. You will shop around for offers from different lenders, submit documents, close your new loan, and pay off the old one.
If circumstances change — such as deciding to stay in your home longer — you can switch from an ARM to a fixed-rate mortgage. This process is similar to renovating other types of mortgages: shop fees, submit documents, close your new loan, and pay off the old one.
Advantages and disadvantages of adjustable rate loans
As with any type of mortgage, ARMs have their pros and cons. Working with a trusted loan officer can help you find the right loan for your needs. But, here are some basic things to keep in mind when starting your journey.
Benefits
- The possibility of reducing the initial interest compared to fixed loans.
- The monthly payment is lower if the rates drop before the changes.
- The possibility of strict borrower requirements.
Bad
- Monthly payments may also increase after the fixed term is over.
- Complex terms make pricing more difficult with fixed rate loans.
- Less long-term stability compared to fixed income loans.
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