When getting a mortgage, one of the biggest decisions is whether to go with a fixed or adjustable interest rate Adjustable-rate mortgages (ARMs) have fallen out of favor since the housing crash more than a decade ago But today’s ARMs are not the risky products they once were. For certain buyers or situations, an ARM can provide significant benefits over a fixed-rate mortgage.

What is an Adjustable-Rate Mortgage (ARM)?

With a fixed-rate mortgage, your interest rate stays the same for the entire loan term, usually 15 or 30 years. An ARM works differently:

• You get a fixed rate for the first 3 5 7 or 10 years of the loan (known as the introductory period).

• After the intro period, the interest rate starts adjusting periodically based on market conditions – often annually, but sometimes as frequent as monthly.

• Your monthly payment goes up or down with each rate change.

ARMs today have caps that limit rate fluctuations, avoiding spikes that contributed to foreclosures during the housing crisis.

Now let’s explore 4 potential benefits you can gain by choosing an ARM over a fixed-rate home loan.

1. Lower Payments and Initial Interest Rate

The main appeal of ARMs is the opportunity to secure a lower rate than you may qualify for with a fixed-rate mortgage. Rates on 5/1 or 7/1 ARMs average 0.5 to 1 percentage point lower than 30-year fixed loan rates. This discount can equate to over $100 less per month on a $250,000 mortgage.

Lower rates allow you to stretch your budget further. You can purchase more house for the same monthly payment, or simply have a more affordable payment on your desired home.

2. Pay House Principal Down Faster

Because ARM rates are lower at first, more of your payment goes toward principal during the intro period rather than interest.

Let’s assume a $200,000 loan amount:

• 30-year fixed at 5%: After 5 years, $29,090 of principal paid

• 5/1 ARM at 3% for 5 years: After 5 years, $33,520 of principal paid

Paying down principal faster gives you equity and savings on interest when you eventually refinance or pay off the loan.

3. Buy More House

As mentioned already, the discounted intro rates on ARMs allow you to qualify for a larger loan while keeping monthly payments manageable. This extra borrowing power is key for expensive housing markets.

For example, on a $400,000 home:

• 30-year fixed at 5%: $2,147 monthly payment

• 5/1 ARM at 3%: $1,681 monthly payment

Being able to buy more home for your budget may make an ARM worthwhile.

4. Potential for a Lower Payment After the Fixed Period

ARM detractors point out that your rate and payment can rise after the intro period. But the reverse is also true – your costs could go down.

Rates are tied to indexes like the prime rate or Treasury yields. If these benchmark rates fall, your new adjusted interest rate will decrease too, lowering your monthly mortgage payment.

Is an ARM Right for You?

Adjustable-rate mortgages aren’t for everyone. Before choosing an ARM, ask yourself:

• How long will you keep the home? ARMs favor short-term owners who sell or refinance within 5-7 years. The low initial rates save money during those years.

• Can you handle payment fluctuations? Budget for worst-case payment scenarios in case rates rise down the road.

• Will your income rise? Higher future earnings can offset potentially larger mortgage payments.

• Are you very rate-sensitive? The lower initial ARM rates may provide the affordability you need.

• Are you in a high-cost area? ARMs allow bigger loan amounts to buy pricier properties.

Also consider if you can refinance into a fixed-rate loan before your introductory rate expires.

Shopping for an ARM Loan

Not all ARMs are created equal. As you compare mortgage lenders, look out for:

Shorter initial terms – A 3/3 or 5/5 ARM keeps rates steady for more years.

Smaller rate caps – Caps of 2% per year and 5% lifetime protect against sharp payment hikes.

Lower margins – The margin added to the index rate significantly impacts interest costs.

Discounted teaser rates – Deeply reduced rates for the first 1-3 years save more initially.

Interest-only options – Paying just interest at first results in very small payments.

Weighing the Pros and Cons

Adjustable-rate mortgages make the most sense for certain borrowers in specific home financing situations. While you give up the safety of a fixed rate, an ARM can provide lower costs in the near-term and flexibility if rates fall.

Look at the big picture of your budget, lifestyle, goals and outlook for interest rates as you consider both the advantages and risks of an adjustable-rate mortgage. An informed decision today can pay off with savings over the life of your home loan.