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Should I consider an adjustable-rate mortgage?

Now that rates on fixed-rate mortgages nationwide have hit 6%, it’s time to think of more affordable alternatives for financing a new home. Tropical Financial offers several mortgage choices that can provide a lower starting monthly payment of principal and interest. Click here to learn more.

With a fixed-rate mortgage, your interest rate does not change from the time you lock it in during the application period to the time you pay off the loan. That can be after the 15-year or 30-year term or when you sell your home.

An adjustable-rate mortgage, or ARM, re-sets the rate – up, down or not at all – on a regular schedule which is most often after 6 or 12 months. The rate fluctuates with a published index that you can easily find online or read in many financial news sites. The most common ones are the one-year U.S. Treasury bill; U.S. prime rate; 6-month CD rate; and SOFR, an acronym for the Secured Overnight Financing Rate.

You will pay that rate plus a margin. On an ARM based on the one-year Treasury index, when that rate is 3% and the margin is 2 percentage points, the starting ARM rate will be 5%.

You don’t have to know how ARM rates are calculated to understand what they mean for your personal finances. When leading interest rates are trending upward, you can expect all of those indices will, too. What you need to know is how often your lender will adjust your payment. It could be as quickly as every month, once a year, or for some ARMs every initially three or five years.

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When considering an ARM, ask yourself these questions:

  • How long do you plan to live in the home you are buying? The average homeowner moves every eight years, according to the National Association of Realtors. If you plan to move in two or three years, you may find an ARM better fits the timeline if the starting rate is well below that of a comparable fixed-rate mortgage. If you plan to live in the home 10, 15 or 20 years, you may want a fixed-rate mortgage. If rates fall significantly during the life of the loan, you can refinance it at a lower fixed rate and pocket the loan interest savings.
  • How much can the rate change at the first adjustment date, subsequent dates, and over the life of the loan? Look for ones that can rise the fewest percentage points to protect yourself against higher payments that could jolt your monthly budget. Don’t be surprised if you find that the ARM rate can rise 5 percentage points or more over the life of the loan.
  • Which adjustment period best fits your plans? Here’s where things get a little complicated. Let’s say you plan to move in five years. You might want a five-year ARM because the rate will, in effect, never change. You will be out of the house and on to the next one before the initial rate adjustment. 
  • How do the points, closing costs and related expenses compare to those of a fixed-rate mortgage? Be sure you are comparing apples to apples and uncovering hidden costs. A point is 1 percent of the loan amount. The more points you pay, the lower the rate. Therefore, you want to put side by side a fixed-rate mortgage and an ARM that have an identical number of points. Then, compare what else you will pay before or at closing to learn which has lower upfront expenses.

With ARM and fixed-rate mortgage information in hand and a good idea of when you might move, you can calculate whether an ARM will save you money. One way to approach this is to look at payments of principal and interest over the first five years. How much less will the ARM cost if its loan rate doesn’t change? How much will you save if ARM rates rise 1 percentage point? 2 percentage points?

Right now, Tropical Financial is offering a 5/6 ARM. The numbers mean that the initial rate does not change for the first five years. After that, it can rise or fall every six months based on the SOFR index. The loan is set up so that the mortgage rate will not increase more than 1 percentage point at each adjustment date and no more than 5 percentage points over the life of the loan. For more information, visit our adjustable-rate mortgage page or call 888-261-8328 to speak to a TFCU mortgage loan officer.

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