A variable-rate mortgage, or an Adjustable Rate mortgage (ARM), is a home loan with a fixed period in which the initial interest rate remains the same for three to ten years, followed by yearly periodic interest rate adjustments.
With the low-interest rate, variable-rate mortgages may seem attractive to homebuyers. However, homebuyers must be mindful of the pros and cons of variable-rate mortgages and consider what is best for their financial situation.
Here, we will discuss the pros and cons of a variable-rate mortgage, so you can determine if this mortgage loan option is right for you!
How do Variable-Rate Mortgages Work?
A variable-rate mortgage is a 30-year mortgage with an initial fixed period, varying from three to ten years based on your loan terms, with the interest rate adjusting each year following.
When the interest rate adjustment occurs, the principal interest within your loan is recalculated, and you will pay the new monthly payment. Each year or every six months, depending on your loan terms, your loan will adjust and continue until the loan is paid off.
Pros of a Variable-Rate Mortgage
Variable-rate mortgages typically gain popularity as home prices increase because the initial monthly payment is lower than a fixed-rate mortgage. As a result, homeowners can purchase a more expensive home with a variable-rate mortgage.
So what are the advantages of an adjustable-rate mortgage versus a fixed-rate mortgage? These may include:
- Variable-rate mortgages have an introductory, or teaser, initial interest rate for a specified period, which is customarily lower than a fixed-rate mortgage. After the introductory period, the interest rate fluctuates according to the mortgage terms.
- Homebuyers can more easily qualify for a variable-rate mortgage because the initial monthly payment is lower.
- Homebuyers can purchase a more expensive home because the initial monthly payment is lower.
- Variable-rate mortgages provide more flexibility than fixed-rate mortgages.
- Homebuyers with a fluctuating income from periodic bonuses and commissions can benefit from the lower monthly payments of a variable-rate mortgage because they can make lump-sum payments throughout the year.
- Homebuyers who will be in their home for a short time, and anticipate a stable or declining interest rate environment, can take advantage of low introductory rates since they will be selling in a few years.
- Homebuyers monthly payments could potentially decrease if interest rates fall.
Cons of a Variable-Rate Mortgage
Homeowners with a variable-rate mortgage share the risk of rising interest rates with the lender; therefore, these mortgages have more inherent risk. For this reason, variable-rate mortgages are not suitable for most homebuyers.
Disadvantages of a variable-rate mortgage compared to a fixed-rate mortgage include:
- Payments fluctuate after the introductory period. Homeowners must adjust their monthly household budget as their mortgage payments increase and decrease.
- Monthly mortgage payments increase if interest rates rise. Homeowners must have the means to pay a higher mortgage if interest rates move upward.
- Variable-rate mortgages are more complex than fixed-rate mortgages, so the loan terms and the vocabulary can be confusing.
- Some vocabulary homeowners with a variable-rate mortgage should know include adjustment frequency, adjustment index, margin, cap, and ceiling.
Who Might Choose a Variable-Rate Mortgage?
Variable-rate mortgages are generally recommended for people who anticipate declining interest rates, plan to live in a particular home for a few years, or anticipate paying off their mortgages before the interest rate adjustment period. These homebuyers must also have the disposable income to make higher mortgage payments if they stay in the home longer and interest rates rise.
While a variable-rate mortgage can be a powerful financial tool resulting in significant savings, it may not be the best choice for some homebuyers. The majority of people purchasing a home will choose a fixed-rate mortgage because of the stability it provides over the long term.
Marimark Mortgage is based in Tampa, Florida, and serves the mortgage needs of homebuyers, homeowners, and investors in Florida, Virginia, and Pennsylvania.
We specialize in adjustable-rate mortgages, conventional home mortgages, FHA, VA, and USDA mortgage options, refinance loans, and reverse mortgages. We have worked extensively with cash-out refinancing and help clients to lower their monthly mortgage payments.
Updated on January 26, 2023