Rising home prices and interest rates are encouraging more and more homebuyers to consider adjustable rate mortgages (ARM). ARMs are still much less popular than fixed-rate mortgages, but now we are seeing a renewed interest in them. Now the question is: Should you opt for an ARM, especially when you consider the fact that it is risky?

First time buyers are finding it difficult to buy a property in the existing real estate market conditions but that is hardly surprising. The average interest rate on a standard fixed-rate mortgage went up by 16 percent during the last year. Home prices, too, have increased. This has prompted more and more buyers to turn their attention to adjustable rate mortgages.

Market watchers still believe that adjustable mortgages were responsible for the housing boom and bust. But this has not prevented many borrowers from inquiring about ARMs.

If you are considering an ARM, you will definitely want to know its pros and cons.

Is ARM the right choice for you?

ARMs are risky, but thanks to stringent underwriting standards, today’s ARMs are much more conservative. They have relatively longer fixed interest periods of 5, 7 or 10 years. In addition, they come with lifetime rate caps, so borrowers will not see a huge jump in their EMI.

Right now, only those borrowers who can document their income are eligible for ARMs. Borrowers also need to prove their financial capacity to pay the highest interest rate that may come with ARMs.

As per the qualified-mortgage rule, lenders have to underwrite home loans based on the borrower’s financial capacity to repay.

The advantages of getting an ARM

When you choose an ARM, the interest rates are adjustable. The teaser rate will be applicable for the first 3, 5, 7 or 10 years. Afterwards the interest rate is revised periodically. This fully indexed interest rate is determined by the performance of key benchmark indexes.

Who should consider ARMs?

Adjustable mortgages are ideal for people who will be occupying the house for a short period of time. People who have enough guaranteed income to manage a higher rate, too, can consider them.  However, if you intend to stay in the house for a long period of time, you should opt for a fixed-rate mortgage.

If you are still interested in an ARM, you should ensure that you can manage the risks associated with them. You can’t simply assume that after a few of years, you will have no difficulty refinancing your mortgage into something lower. It is also wrong to assume that value of your home will rise significantly over the next few years. All of these are mere assumptions. And hence before choosing adjustable mortgages, you should do your homework.

Since fixed rates are at their bottom lows right now, it is safe to assume that rates will only rise during the next few years. This increases the risks associated with ARMs.

You should know what your monthly EMI would be if the rates went up to their highest cap. If you are confident that you will be able to pay them, you should perhaps consider getting an adjustable mortgage. Otherwise, you will be better off sticking to fixed-rate mortgages.

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