How Adjustable-Rate Mortgages Could Save You Thousands

written by

Jim Mucci

posted on

November 25, 2024

adjustable rate mortgages savings potential

Getting a home loan that can change its rate over time might help you save money. These loans start with lower monthly payments than regular home loans. Let's say you get a loan that stays the same for five years. During this time, you pay less each month and keep more money in your pocket. This works well if you want to move or get a new loan before the rate starts to change. The loan has rules that stop the rates from going too high, so you don't have to worry about big jumps in your payments. Many people choose these loans to save money while they live in their home.

What Are Adjustable-Rate Mortgages

Your mortgage rate changes with time when you get an adjustable-rate mortgage, or ARM. Unlike fixed-rate loans, ARMs start with a low rate that stays the same for a few years. After that, your rate goes up or down.

You might get a rate that stays the same for 3, 5, 7, or 10 years. Then it starts to change. Your lender will put limits on how high your rate can go. This helps protect you from big jumps in your monthly payment.

The name of your ARM tells you how it works. If you see "5/1," that means you get the same rate for 5 years. After that, your rate can change once every year. Your new rates will depend on what's going on in the money world, plus a little extra that your lender adds.

Understanding ARM Rate Caps

When you get an ARM loan, think of rate caps as your safety net. They stop your monthly payment from getting too big too fast. Just like a lid on a jar, these caps keep things from spilling over.

There are three main caps to know about:

First cap: This one kicks in after your first rate change. It makes sure your first jump isn't too big.

Regular caps: After that, there are caps that work each time your rate can change. Most of the time, your rate can only go up by 2% each time.

Big cap: This is the highest your rate can ever go. Most loans won't let the rate go up more than 5% from where you started.

Rate caps help you plan ahead. You can see how high your payments might get and decide if this kind of loan works for you.

ARM Vs Fixed-Rate Mortgages

When buying a home, you need to pick between two types of loans. You can get a loan where your payments stay the same, or one where they can change.

A fixed-rate loan means you pay the same amount each month. This makes it easy to plan your budget. You won't have to worry if rates go up, but you'll pay more at first.

The other type is called an ARM. It starts with lower payments, which can save you money. This works well if you plan to move soon or think you'll make more money later.

But be careful – your payments could go up if rates rise.

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Think about what matters most to you. Do you want the same payment every month? Or would you rather pay less now and take a chance on rates going up later?

Pick the loan that helps you sleep better at night.

The Initial Fixed Period

Getting a loan for your home can be fun to learn about. You start with a set payment that stays the same each month. This first part is nice because you pay less than most other home loans. It can last from six months to ten years. This gives you time to make a good money plan.

Let's look at the types:

A 3/1 loan keeps the same rate for three years
A 5/1 loan stays the same for five years
A 7/1 loan gives you seven years at one rate
A 10/1 loan keeps your rate the same for ten years

Think about when you might want to move or change your loan. Pick a loan that matches your plans. If you want to sell your home soon, you can save money with the lower rate at the start.

When ARMs Make Financial Sense

ARMs, or adjustable-rate mortgages, can be good for you in a few cases.

If you want to sell your home soon, you can use the low rate at first and move before it goes up. This works well if you know you'll make more money soon, like when you finish doctor training or school.

You might like an ARM if you think rates will go down later. This way, you can switch to a better rate when that happens.

If you buy a house to rent out for a short time, the low payments at first help you save money. Just be ready with a plan B, and make sure you can pay if rates go up and your plans change.

Common ARM Types

Let's talk about ARMs – these are home loans that can change over time. Think of them like a loan that starts one way and then changes later. The names use two numbers with a slash between them.

A 3/1 ARM keeps the same rate for three years. After that, it changes once every year.

A 5/1 ARM stays the same for five years before it starts to change each year.

Want more time before changes happen? You can pick a 7/1 ARM, which stays the same for seven years. Or try a 10/1 ARM, which won't change for ten whole years.

After the first part ends, all these loans change once every year.

3/1 and 5/1 ARMs

ARMs like the 5/1 help you save money at first. You pay the same rate for five years. Then your rate can go up or down each year.

Think of it like a starter home for your money. You get a good deal up front. This works well if you want to move or get a new loan in five years or less.

Your monthly payments stay the same for five years. You know what to pay each month. If rates drop later, your payments can drop too. You don't need a new loan to get lower rates.

You can:

Make the same payment for five years
Pay less each month than with a 30-year loan
Watch your home value grow
Switch to a fixed-rate loan if rates start going up

7/1 and 10/1 ARMs

When you get a 10/1 ARM home loan, your rate stays the same for ten years. This means your monthly payment won't change during this time. Many people like this because they know what to pay each month.

After ten years, your rate can go up or down each year. The new rate depends on what's happening with money in the world.

Here's how it works:

Years 1-10: Your rate stays the same
Year 11: Your rate changes for the first time
Years after that: Your rate changes once every year
Year 30: You make your last payment

This loan often starts with a lower rate than other 30-year loans.

It works well if you:

Think you'll make more money later
Plan to move in less than ten years
Want to sell your home before the rate changes
Hope to get a new loan before the rate changes

Calculating Potential Savings

When you look at home loans side by side, you can see how much money you might save with an ARM loan. An ARM loan starts with a lower rate than a fixed loan. This means your monthly bill will be less at first.

To see how much you can save:

Take your fixed loan payment
Take away your ARM loan payment
This shows how much less you pay each month

To get the most from your ARM loan:

Add up all the money you save each month
Think about how long you want to live in your home
Look at different ARM loan choices (3 years, 5 years, 7 years)
Use the extra money you save to pay your loan faster or save for later

Many people save hundreds of dollars each month in the first few years with an ARM loan. This can add up to big savings over time.

Current ARM Market Trends

Looking at home loans that can change over time, we call these ARMs. Right now, these loans cost a bit more than last year, but they still save you money compared to regular loans.

Fewer people are picking ARMs today – only 8 out of 100 new loans are ARMs. This is less than last summer when 12 out of 100 people picked ARMs.

Many people want loans that stay the same now because money things keep changing. Money experts think ARM costs will go up and down next year. If the big banks make some changes, ARM costs might go down.

Recent ARM Rate Movements

ARM rates have been going up and down a lot this year. The rates moved between 5.5% and 7%. When the Fed makes changes, mortgage rates change too.

If you get an ARM loan, you'll start with a lower rate than a regular 30-year loan. This lower rate stays the same for 5, 7, or 10 years. After that first period ends, your rate will go up.

The extra amount added to your rate after the first period is now bigger. It used to be 2.75% but now it's 3%.

Banks now use a new way to set your rate changes. They switched from LIBOR to SOFR.

Banks are also being more careful about how high your rate can go. Many now only let rates go up 4% from where you started. Before, they let rates go up 5%.

Market Share vs. Fixed

Think of mortgage loans like choosing between a game with changing rules or one where the rules stay the same.

Right now, only 8 out of 100 people pick loans where the payments can change. This is less than last year when 12 out of 100 people picked them.

Most people like loans where their payments stay the same each month. In fact, 92 out of 100 people pick this kind. It's like knowing you'll pay the same amount for your lunch every day.

Let's look at what each type offers:

Loans with changing payments:

Start with lower costs
Can help you save money

Loans that stay the same:

You know what to pay each month
No surprises for many years

If you plan to move to a new house soon, a loan with changing payments might save you money.

But if you want to stay in your house for a long time, most people like knowing their payments won't change.

2024 ARM Rate Predictions

ARM Rates in 2024: What to Watch For

Rates for adjustable mortgages will go up and down next year. Let's look at what might happen so you can make smart choices about your home loan.

The first three months will see rates drop a bit. The Fed will make it easier to borrow money, and rates might fall by up to half a point.

Then, as more people spend money and business picks up, rates will climb from spring to summer. They could go up by as much as three-quarters of a point.

Late summer will be quiet. Rates will stay steady while everyone looks at how the world's money is doing.

At the end of the year, banks will try harder to get your business. This means rates might drop again by about a quarter point.

These ups and downs affect when you might want to get a home loan or change the one you have. Many other people like you keep an eye on rates too, so they can save money on their homes.

ARM Qualification Requirements

Getting an adjustable-rate mortgage is harder than a normal home loan. You need better credit – at least 620. You also need less debt compared to what you make.

You must show you make steady money and have savings in the bank. This helps cover bigger payments if rates go up. Banks want to make sure you can pay more each month, so they test if you can handle rates that are 2-3% higher.

You'll need to show lots of papers about your money. This means bank papers from the last two months, your pay stubs, and tax papers from two years.

You might also need to put down more money at first – about 5-10% of the home price.

Risk Management Strategies

Let's shield you from higher costs by locking in your rate with your bank.

Think of it like putting up an umbrella before it rains. You need to save money too – put aside enough to pay your house bills for six months.

This money acts like a safety net when rates go up. Keep this money safe, and you won't worry when your payments change.

Lock-In Rate Options

When rates keep changing, you can protect your monthly payments with rate locks. These are like a promise from your lender to keep your rate the same.

Think of it as putting a shield around your payment to keep it safe.

Many banks let you lock your rate before it goes up. This helps you know exactly what you'll pay each month.

You can get:

A short lock for 30-60 days, which costs less
A longer lock for 90-180 days, which costs more
A special lock that lets you pay less if rates drop
A rule that stops your rate from going too high

Talk to your bank soon about locking your rate. This way, you won't miss your chance to save money.

Emergency Fund Planning

Having extra money saved up helps protect you when your mortgage payments change. Think of it like a safety net for your home.

The more you make each year, the less you need to save:

If you make under $50,000: Save 9 months
If you make $50,000-$100,000: Save 8 months
If you make $100,000-$150,000: Save 7 months
If you make $150,000-$200,000: Save 6 months
If you make over $200,000: Save 5 months

To figure out how much to save:

Find out the highest payment you might've to make
Take away what you pay now
Times that by how many months you need to save

Put this money in a savings account that pays you good interest. This way you can get to it fast when your payments go up.

ARM Refinancing Options

When you have a mortgage where the payments can change, you can switch to a better loan.

Let's look at your choices in simple terms.

You can pick a loan that keeps the same payment each month. This is good if you want to know exactly what to pay.

You can get a new loan that still changes but has better rules about how much it can go up. This might give you lower payments at first.

You can choose a special loan that stays the same for many years before it starts to change. This gives you more time with safe payments.

You can also get cash from your home's value while getting a new loan. This helps if you need money now.

Look at how much it costs to switch loans.

Think about how long you want to stay in your home. This will help you pick the best choice for you and your family.

Consumer Protection Features

We want to protect you when you get a special home loan where payments can change.

Your loan comes with helpful rules that keep your costs under control. These rules make sure your monthly payments won't jump too high, too fast.

There's also a top limit on how much you'll ever have to pay. This way, you can feel safe knowing the most your loan will ever cost.

Interest Rate Adjustment Caps

When you get a mortgage where rates can change, there are rules that keep your payments from going up too much. These rules are called "caps" and they help protect you and your money.

The first cap shows how much your rate can go up when your loan first changes.

The next cap shows how much your rate can go up each time it changes after that.

The biggest cap shows the highest rate you'll ever have to pay.

Some loans also have a cap on how much your monthly payment can go up.

These caps keep you safe. They help you know the most you might need to pay each month. This way, you won't get any big surprises with your house payments.

Payment Change Safeguards

Adjustable-rate mortgages help keep you safe from big payment changes. They come with rules that make your payments easier to handle.

Let's look at how these rules protect you:

Safety Rule	What It Does	How It Helps You
Payment Limits	Stops big jumps in what you pay	Your bills stay more steady
Starting Period	Keeps your rate the same at first	You know what to pay early on
Rate Switch Choice	You can change to a fixed rate	You can lock in if rates go up
Balance Guards	Stops too much debt buildup	Keeps your home worth more

When you know these safety rules, you can pick the right loan. This helps you plan your money better and feel more secure about your future payments.

Lifetime Rate Limits

Rate limits protect you from paying too much on your home loan.

Think of them as a safety net that stops your payments from getting too big.

When you get your loan, you'll know the highest rate you'll ever have to pay.

Most loans won't go up more than 5-6% from where they start.

You can find out your biggest possible payment before you agree to the loan.

Your bank must tell you this number up front.

With these limits, you can feel safe knowing your payments won't surprise you.

Many people choose these loans because they know their payments can only go up so high.

ARM Payment Structure

Getting a special home loan means your payments work in two ways.

First, you start with a set payment that stays the same for a few years. This first part can last 3, 5, 7, or 10 years. Your bank helps you pick how long.

Then, your payments can go up or down based on what's going on with money in the world. The bank will tell you before your payment changes. These changes happen every 6 or 12 months.

You might pay less at first, but you need to save money in case your payments go up later. Think about if this kind of loan is right for you and your money plans.

Lender Selection and Negotiation

Finding the right bank for your home loan takes time. You need to look at many banks to get the best deal. Each bank will give you different rates and fees. This is why you need to look around.

Here's what to do: