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After making your down payment, the last thing you want is hefty monthly repayments on your mortgage. Thankfully, you can benefit from a low introductory rate with an Adjustable Rate Mortgage (ARM).

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What is an Adjustable Rate Mortgage?

As the name suggests, the rate adjusts up and down during the loan term. If the market rate increases, the ARM follows suit and if the rate decreases, your rate falls too. There are several ARMs to choose from, but the most popular trio are the 3/1, 5/1 and 10/1 options.

In the above figures, the first number refers to the amount of years your rate is fixed. The second number relates to the amount of times your rate can change during a year. For example, a 5/1 ARM means the first 5 years of your loan features a fixed rate. Once this period is up, your rate can adjust once a year for the remainder of your loan term.

If you have a 30-year 10/1 ARM, you can budget for the first 10 years as the rate will not change no matter what. Once this time is up, your mortgage rate could change once a year for the next 20 years. This sounds frightening because, in theory, your interest rate could rise for 20 consecutive years. In practice, however, you’re protected.

ARM Caps – Protection When You Need It Most

Once you have an ARM, you can set payment, periodic and lifetime caps:

  • Payment Cap: This lets you set a limit on how high your rate can increase. This enables you to remain within budget and stay protected against market uncertainty. However, a payment cap can cause negative amortization. This is when your repayment doesn’t cover the amount of interest owed. If the market rate skyrockets and you can only change your rate once a year, you could end up making payments that don’t cover your interest for a year.
  • Lifetime Cap: Limits the amount your rate can adjust over the duration of your loan term.
  • Periodic Cap: Limits the amount your rate can adjust over a set period.

Advantages of Adjustable Rate Mortgages

The low introductory rates, coupled with the caps, give you the opportunity to save tens of thousands of dollars over the course of your mortgage. Obviously, you also benefit if the interest rate falls. Let’s take a look at how you could save with an ARM.

Let’s say a lender offers you a 5/1 (30-year) ARM with an introductory rate of 2.872% for the first 5 years. If you pay $60,000 down on a $240,000 mortgage, the monthly interest and principal payments are under $1,000, and you will pay over $27,000 principal in the first 5 years.

In contrast, a 30-year fixed-rate mortgage with an APR of 4.3% would result in monthly payments of over $190 more. In this example, you’ll save over $11,000 in the first 5 years with an ARM.

If you know you could be selling the property within 5 years, the introductory rate could be a fantastic deal.

Disadvantages of Adjustable Rate Mortgages

You are at the mercy of the market to some extent because an interest rate increase means you pay more each month. Although you can set caps, this might lead to negative amortization. Also, you can’t set a budget after the fixed term is over because you don’t know which way the market will turn.

Interest rates have increased in recent times, and the Federal Reserve has admitted that it will probably increase them again in the near future. According to most economists, a rate rise is likely, so if you plan to live in your home for at least a decade, a fixed rate mortgage is probably your best bet.

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We have witnessed countless customers stress themselves to the limit in the pursuit of an affordable conventional mortgage. We’re here to tell you:

It Doesn’t Have To Be This Way!

Thanks to our burgeoning reputation within San Diego and Southern California, we have forged links with the best mortgage lenders in the region. As a result, we can help you gain pre-approval in approximately one minute, and the funds could be in your account just one month after approval.

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As well as providing you with a wealth of financing options, we’re on hand to provide you with the best advice. For example, if you want to live in your home for decades, a fixed term mortgage is the right choice. In contrast, someone likely to move out within seven years should consider an ARM.

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