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It could save you some money, but there are risks involved.
Although home prices have been elevated for several years now, in 2020 and 2021, buyers were at least able to offset those soaring prices with affordable mortgage rates. In fact, if you had great credit back then, you could pretty easily lock in a 30-year fixed-rate mortgage at or around 3%.
But borrowing rates have skyrocketed over the past year. And now, the cost of signing for a mortgage is more than double what it was at the end of 2021.
Now there are certain steps you can take as a mortgage borrower to snag a lower interest rate on a home loan. Improving your credit score, for example, could make borrowing a bit less expensive for you. So could shopping around with different lenders rather than signing the first mortgage offer you receive.
But there may be another move you can make to score a lower mortgage rate. Often, signing an adjustable-rate mortgage, or ARM, will give you some savings.
But does an ARM make sense this year? While you might enjoy some savings on your mortgage rate initially, you could end up taking on a really big risk.
Why ARMs can be dangerous
You might snag a lower mortgage rate for a few years when signing an ARM than you would with a fixed-rate loan. But you’re not guaranteed that lower rate for the reminder of your loan term.
At some point, the interest rate on your mortgage could climb, making your loan payments far more expensive. With a fixed-rate mortgage, you don’t take that risk.
Now, a lot of people sign an ARM with the plan to refinance their mortgages once borrowing rates drop. But the reality is that we don’t know what the next bunch of years have in store for mortgage rates.
So, let’s say you sign a 5/1 ARM, which means the rate on your mortgage can adjust once a year after five years. It may be the case that mortgage rates are higher at that point than they are today. That means refinancing probably won’t be feasible or worthwhile, thereby leaving you stuck to bear the cost of a rising interest rate.
Of course, the opposite could happen — mortgage rates could drop, making it possible to refinance out of an ARM as or before your rate starts to climb. And also, the rate on your ARM isn’t guaranteed to climb. It could actually drop over time, making your mortgage payments less expensive on a monthly basis without you actually having to do anything.
But is that a risk you’re willing to take with what’s probably your largest monthly expense? If the idea of a higher mortgage payment over time scares you, then a fixed-rate loan may be the best way to go — even with borrowing rates being higher these days than they’ve been in a long time.
Don’t rush into an ARM
Signing an ARM might work out well for you. But before you make that call, consider the alternatives. You may end up swapping some near-term savings for higher costs down the line, when you’re not actually able to handle them.
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