Everything You Need to Know About a 30-Year ARM
Published April 30, 2022
Selecting a loan program for your upcoming mortgage refinance or home purchase is important. The program that you choose can impact everything from how quickly you accumulate equity to your monthly mortgage payment and your total interest charges over the life of the loan. A 30-year ARM may hold considerable appeal for some homebuyers and owners. However, while it comes with exceptional benefits, there are also some disadvantages that you should be aware of before you finalize your selection of a loan program.
What is a 30-Year ARM?
An ARM is an adjustable-rate mortgage. A 30-year ARM generally has an initial fixed-rate period, and the interest rate will adjust regularly after that period expires. For example, you may commonly see an ARM written as a 5/1 or a 7/1. This means that the loan will have an initial fixed-rate period of five or seven years and a term of 30 years. The interest rate is fixed for that initial period, which means you will have a regular mortgage payment for the first years of the loan.
However, after that fixed period expires, the rate will readjust every year. As a result, the rate may go up or down depending on the market conditions at the time. Usually, there are upper and lower caps on the rate, but the adjustment can still be substantial. As the rate adjusts, your mortgage payment will also fluctuate. This will continue until the loan is paid in full or until you refinance the loan.
The benefits of a 30-year adjustable-rate mortgage
Low interest rates are among the biggest reasons why an ARM has substantial appeal. Compared to a 30-year fixed-rate loan, the first few years of an ARM usually have a lower interest rate. Because of this, an ARM also will give you a lower initial mortgage payment. This can equate to significant monthly savings for those first few years of the loan. If you are buying a new home, the lower interest rate and monthly payment could help you qualify for a larger loan and get into a nicer or larger home. If you are preparing for a mortgage refinance, the ability to qualify for a larger loan amount may help you pull out more equity later on.
Keep in mind that you will pay less in interest charges during the initial fixed-rate period with an ARM because of the lower rate. As a result, when done strategically, your total interest charges with a 30-year ARM may be lower than your total interest charges with a 30-year fixed-rate mortgage. However, you could pay substantially less interest overall if you choose a 15-year refinance or purchase loan rather than a 30-year loan.
The drawbacks of a 30-Year adjustable-rate mortgage
While a 30-year ARM has initial benefits, those advantages could fade after the fixed-rate period of the mortgage expires. The interest rate for an adjustable-rate mortgage can increase dramatically in some cases, resulting in a much higher mortgage payment than what the homeowner may be accustomed to. This can have a major and perhaps detrimental impact on your monthly budget. For some homeowners, the mortgage payment becomes unaffordable, and the best choice at that time is to sell the home. Keep in mind that the interest rate will continue adjusting over the remaining life of the loan. This can make budgeting a challenge. It may also impact your ability to save money or achieve other financial goals.
When a 30-Year ARM makes sense
A 30-year ARM may be a good option if you buy a home today, but expect to see your financial situation improve within the next few years. For example, you may finish up a higher-level college degree and qualify for a higher-paying job before your ARM adjusts. A 30-year ARM may also make sense if you have a sound exit plan in place if the rate becomes unmanageable. For example, you may plan to do a mortgage refinance to a 30-year fixed-rate loan when the rate adjusts. This is also a popular loan for those who know they want to move in the next few years. Be aware, however, that it can be difficult to predict what interest rates will be in a few years. This means that refinancing in the future may not always be feasible or advantageous.
Do you have a 30-year ARM currently that is about to adjust? A 15-year refinance could make financial sense at this time. We are in a rising interest rate environment, and your ARM’s interest rate may continue to adjust higher over the next several years or longer. A 15-year fixed-rate mortgage will lock in today’s low interest rate and help you pay off the loan sooner.
When to choose a fixed-rate mortgage
While there are instances when a 30-year ARM makes sense, there are also times when it is more advantageous to choose a fixed-rate mortgage. With a fixed-rate mortgage, your payment remains the same for the life of the loan. For example, with a 15-year refinance loan, your mortgage payment will be the same this month as it will be in the 15th year of the loan. Of course, market conditions can change dramatically over the life of a loan, but you can enjoy simplified budgeting efforts because your mortgage rate and payment are fixed. Because of this, a fixed-rate mortgage is preferable to homeowners and buyers who want financial stability.
A mortgage refinance in the future could be a possibility if you choose an ARM today. However, there is no certainty that the rates at that time will be favorable. Therefore, if you do not want to be forced into refinancing or selling before you are ready to do so, a fixed-rate mortgage may be more strategic.
Explore the possibilities today
Before you take out a 30-year ARM, it makes sense to compare this with the option of a 15-year refinance or purchase loan. In most cases, a 15-year loan comes with a lower rate than a 30-year fixed-rate loan. It also gives you the advantages of a fixed interest rate and a stable mortgage payment throughout the life of the loan. After comparing the possibilities in full detail, you can make your final decision with the highest degree of confidence. If you’re unsure which is the best option for you, schedule an appointment. We’d be happy to help you explore your options.