When you get a home loan, you will need to decide whether you want a fixed rate loan or an adjustable rate loan (ARM). With an ARM, the rate can adjust over time unlike a fixed rate which remains the same throughout the life of the loan.
Typically, an ARM has a lower starting rate than fixed rate loans, which can make it attractive because it is more affordable. But it is only blocked for a short time. It could be locked down for just five years (an ARM 5/1) or seven (an ARM 7/1). After this time, it adjusts with a financial index, and the rate, monthly payment and total cost of the loan could increase.
If you are considering getting an ARM, you might want to make sure you make a good size down payment. While a 20% down payment is always beneficial in order to have a good choice of lenders and avoid getting stuck paying for private mortgage insurance, making a generous down payment can be even more important with an ARM.
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A low down payment makes an ARM riskier
Making a good-sized down payment – ideally 20% and certainly no less than 10% – is important when taking out an ARM because if you put in too little money it could cause problems later.
When you have an adjustable rate loan, there is a good chance that your rate will start to adjust upwards after the initial period with the fixed interest rate expires.
Many people who get ARMs don’t really want to take the risk of whether the interest charges on their loans will increase each year, potentially making their payments unaffordable. Instead, the goal is often to sell the home before the initial rate begins to adjust or to refinance into another ARM or even into a fixed rate loan before the rate begins to adjust. .
If you sell the house before the rate adjustments, you benefit from the lower starting interest rate offered by ARM without having to risk paying high rates later. And if you refinance before it starts to adjust, then you get that low rate for a few years and then can either get another low interest ARM to extend that period for a few more years or get a fixed rate loan and enjoy the certainty that loan type offers.
The problem, however, is that you can’t refinance or sell your home if you owe more than the property’s value. And if you don’t put in a generous down payment, chances are it will happen if property values ââdrop even a little. If your home is losing value and you can’t sell it enough to pay off your loan, or you can’t qualify to refinance your mortgage, you could be stuck in your ARM once rates start to climb. adjust.
You don’t want to be trapped with a loan that adjusts and potentially makes payments more expensive. In this case, you may not be able to do anything about it because you are underwater with your loan. A large down payment ensures that this will not happen, which greatly reduces the risk of losing an ARM.
If you are considering getting an ARM and you don’t have much to do, you might want to reconsider whether this decision is the right one in the long run.