Include lower rates and payments early on in the loan term. Because lenders can use the lower payment when qualifying borrowers, borrowers can purchase larger homes than they otherwise could buy.
Allow borrowers to take advantage of falling rates without refinancing. Instead of having to pay a whole new set of closing costs and fees, ARM borrowers just sit back and watch their rates fall.
Aid borrowers save and invest more money. Someone who has a payment that's $100 less with an ARM than with a FRM for a couple of years can save that money and earn more off it in a higher-yielding investment.
Offer a cheap way for borrowers who do not plan on living in one house for very long to buy a house.
Adjustable Rate Mortgages disadvantages
Rates can rise and payments can rise significantly over the life of the loan. A 6 percent ARM can end up at 11 percent in just three years if rates rise.
The borrower's initial low rate will adjust to a level higher than the going fixed rate level in almost every case even if rates in the economy as a whole don't change. That's because Adjustable Rate Mortgages have initial fixed rates that are set artificially low.
The first adjustment can be a doozy because some annual caps don't apply to the initial change. Someone with an annual cap of 2 percent and a lifetime cap of 6 percent could theoretically see the rate shoot from 6 percent to 12 percent 12 months after closing if rates in the overall economy skyrocket.
Adjustable Rate Mortgages are difficult to understand. Lenders have much more flexibility when determining margins, caps, adjustment indexes and other things, so unsophisticated borrowers can easily get confused or trapped by shady mortgage companies.
On certain Adjustable Rate Mortgages, called negative amortization loans, borrowers can end up owing more money than they did at closing. That's because the payments on these loans are set so low (to make the loans even more affordable) they only cover part of the interest due. Any additional amount due gets rolled into the principal balance.
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Rates and payments remain constant. There won't be any surprises even if inflation surges out of control and mortgage rates head to 20 percent.
Stability makes budgeting easier. People can manage their money with more certainty because their housing outlays don't change.
Fixed Rate Mortgages disadvantages
Simple to understand, so they're good for first-time buyers who wouldn't know a 7/1 ARM with 2/6 caps if it hit them over the head.
To take advantage of falling rates, FRM holders have to refinance. That means a few thousand dollars in closing costs, another trip to the title company's office and several hours spent digging up tax forms, bank statements, etc.
Can be too expensive for some borrowers, especially in high-rate environments, because there is no early-on payment and rate break
Are virtually identical from lender to lender. While lenders keep many ARMs on their books, most financial institutions sell their FRMs into the secondary market. As a result, ARMs can be customized for individual borrowers, while most Fixed Rate Mortgages can't.