Adjustable-Rate Mortgages (ARMs) are a type of mortgage loan that have an interest rate that can fluctuate over time based on changes in the market. Here are some details about using an ARM for financing a first home purchase:
- Lower Initial Interest Rates: One of the main benefits of an ARM is that it typically has a lower initial interest rate compared to a fixed-rate mortgage. This can make your monthly mortgage payments more affordable in the short term.
- Adjustment Periods: An ARM has an adjustment period, which is the period of time before the interest rate can change. Common adjustment periods are 3, 5, 7, or 10 years. After the adjustment period, the interest rate can change annually based on the index rate.
- Index Rate: The index rate is a benchmark interest rate that an ARM is tied to. Common index rates include the London Interbank Offered Rate (LIBOR) and the Constant Maturity Treasury (CMT) rate. When the index rate changes, the interest rate on the ARM can also change.
- Caps: ARMs typically have caps on how much the interest rate can change in a given period. A periodic cap limits how much the interest rate can change during an adjustment period, while a lifetime cap limits how much the interest rate can change over the life of the loan.
- Risk: ARMs come with a higher level of risk compared to fixed-rate mortgages because the interest rate can fluctuate over time. If interest rates increase significantly, your monthly payments could become unaffordable.
- Refinancing: If you plan to stay in your home long-term, it may be beneficial to refinance to a fixed-rate mortgage before the adjustment period ends to avoid potential increases in your monthly payments.
Overall, an ARM can be a good option for first-time home buyers who plan to sell or refinance within a few years. However, it is important to understand the risks associated with an ARM and have a plan in place for potential increases in your monthly mortgage payments.
What are the Disadvantages of a Conventional Mortgage Loan?
While conventional mortgage loans are a popular option for many borrowers, there are also some potential disadvantages to consider. Here are a few of them:
- Higher Credit Score Requirements: Conventional loans generally require a higher credit score compared to government-backed loans like FHA and VA loans. This means that borrowers with lower credit scores may not be eligible for conventional loans or may face higher interest rates.
- Larger Down Payment: Conventional loans typically require a larger down payment compared to government-backed loans, with a minimum down payment of 3% for some conventional loans but up to 20% for others. This can be a significant hurdle for borrowers who don’t have a large amount of cash on hand.
- Private Mortgage Insurance (PMI): If the borrower puts less than 20% down on a conventional loan, they may be required to pay for private mortgage insurance (PMI), which is an added cost that can increase the overall cost of the loan.
- More Stringent Income and Debt Requirements: Conventional loans may have more stringent income and debt requirements compared to government-backed loans, which can make it more difficult for some borrowers to qualify.
- Limited Eligibility: Conventional loans may not be available to all borrowers, such as those with low credit scores or who are unable to make a large down payment.
It’s essential to weigh the advantages and disadvantages of conventional loans carefully before making a decision. Speaking with a mortgage professional can help borrowers determine whether a conventional loan is the right choice for their unique financial situation.