Are ARMs worth the risk?


Interest rates and the North Carolina housing market are hot topics. With each rise in interest rates, millions of homeowners are priced out of their local market. Some of these homeowners will consider adjustable rate mortgages (ARMs) to meet their housing needs. While these mortgages are sometimes necessary, they are inherently risky and can cause problems for some borrowers.

What is an ARM?

An ARM is a mortgage where the interest rate changes over time. Mortgages are large loans that individuals or companies take out to make substantial purchases such as for a home. The interest rate for the purchase is charged on a regular basis and is agreed upon due to a variety of factors including government-set interest rates and creditworthiness. Many mortgages have a fixed rate which does not change for any reason other than refinancing. An adjustable-rate mortgage is one where the rate fluctuates due to factors established in the contract. That rate can change multiple times over the life of the loan.

Benefits and drawbacks

Adjustable rate mortgages can greatly increase the amount of money that a borrower has to pay over a thirty-year period. An ARM is usually only worth the risk in a few instances. The first is when interest rates are on a downward trajectory. A borrower and lender can follow those interest rates and see where they might go relative to inflation and other economic indicators. If interest rates are projected to drop, an ARM may make sense since the amount the borrower will pay will go down over time.

Another situation is when a borrower believes that they will soon be able to refinance for a fixed-rate mortgage. They may be waiting until they can qualify for a fixed-rate loan and potentially reduce their monthly payment. Finally, an ARM sometimes makes sense because it is the only type of loan that a borrower can qualify for. These loans often start out cheaper and are more affordable. In those cases, the potential risks of ARM are understandable since they are the only way a borrower can buy their home.