When embarking on the journey to homeownership, one of the most pivotal choices is selecting between fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs). Despite their mixed reputation stemming from the events of the 2008 housing market collapse, financial advisors argue that certain borrowers might find ARMs to be a fitting option under specific circumstances. This article delves into the mechanics of adjustable-rate mortgages and outlines scenarios where they may be advantageous.

When an Adjustable-Rate Mortgage Could Be Beneficial

The main attraction of ARMs is their lower initial interest rates in comparison to fixed-rate options. These introductory rates usually last anywhere from three to ten years, providing considerable savings during the initial phase of homeownership. Financial expert Chad Gammon, CFP, and owner of Custom Fit Financial, notes that these reduced rates can be particularly beneficial for those who expect either rising incomes or decreasing interest rates throughout their loan duration.

Nonetheless, Gammon warns about the potential risks involved: “When the introductory rate period concludes, there’s a chance the rate may increase.” This situation is exemplified by ARMs obtained prior to 2020. He stresses the importance of fully grasping the complexities of ARMs, as they require borrowers to understand what extending beyond the fixed-rate term entails.

Short-term Homeownership

For individuals not intending to stay in one location long-term, ARMs can yield significant advantages. Doug Carey, CFA and founder of WealthTrace, points out that many homeowners tend to move within seven years or less. “If the anticipation is to sell the property before the rate adjusts,” Carey explains, “the lower starting rate provides a financial edge.” By implementing this approach, homeowners can harness the benefit of reduced rates during their intended occupancy while sidestepping potential later hikes.

Affordability in High-Cost Markets

In areas where housing prices are elevated, ARMs can create more opportunities for potential homeowners. The lower initial payments can enable buyers to qualify for homes that may be financially out of reach with traditional fixed-rate mortgages. While this strategy does involve the risk of future rate adjustments, it may still represent a calculated decision for those who foresee income increases or plan to refinance in the near future.

Strategic Refinancing Opportunities

Many borrowers utilizing ARMs intend to refinance before the adjustable phase begins. Carey views this as a potential way to save funds: “By taking advantage of the favorable rates during the initial term, they can refinance at an opportune moment, either to secure a lower fixed rate or to maintain another ARM.” This tactic necessitates astute timing and market insight but can lead to significant long-term savings.

Determining if an ARM Is Right for You

Andre Small, Founder and Financial Planner at A Small Investment, LLC, provides a practical scenario where ARMs might be favorable. He recounts working with a client whose job necessitated regular relocations, yet who still aimed to accumulate equity in real estate. For this client, an ARM offered the flexibility to “reduce debt now while keeping debt levels manageable over a set timeframe.”

When contemplating an ARM, it’s essential for potential borrowers to assess a range of factors:

• Anticipated duration of homeownership
• Career plans and possible income advancements
• Current market conditions and interest rate trends
• Personal risk tolerance
• Long-term financial aspirations

While ARMs can present meaningful benefits under certain circumstances, they demand a thorough evaluation of associated risks and a solid understanding of the loan agreement.