Okay so most people say “ugh no way, awful, too risky.” I say hold on, it depends on why you are getting one in the first place and what type of adjustable mortgage. I’m going to discuss the different types of adjustable mortgages, the pros and cons, and why I personally chose an adjustable mortgage.
First an Option-Arm mortgage, which gives you the opportunity to pay as much or as little as you want per month. If you don’t pay all the interest it just balloons up and you owe more than the house. Pro, very low monthly payment. Con, obviously you can owe more than your house is worth. Whose it for? People who have variable incomes, and maybe have some lean months, but some great times, so they can pay it off. Great for people who maybe have huge bonus or commission checks. Not great for people stretching to buy a home. Also good for people interested in paying off the home super fast and a low interest rate will allow them to achieve this goal faster.
Second, Interest-Only Arms, a mortgage where you only pay the interest on the loan for a fixed period of time. Here typically you have a set number of year 3, 5, or 7 years where you only pay the interest on the loan. Then the loan reamoratizes and you have to pay the principal down faster in the remaining years, along with potentially being hit with a higher rate at the new adjustment. Pro, again a lower monthly payment. Con, if housing prices go down you’ve built no equity up to cushion yourself in case you need to sell. You could owe more than the home is worth. This is mostly for times when homes are going up, if it’s going down, you may not have a valuable asset at the end. So it’s probably for people who like risk, are going to move or have an increase income soon, and the market is going up instead of down. This also works for people who work for commission and thus need more flexibility with their payments. However when they have extra money they pay down the mortgage first.
Finally the standard adjustable rate mortgage, where it stays fixed for 1, 3, 5, 7, or 10 year, then adjusts annually afterwards. Typically the mortgage is amortized from the beginning, and there is an annual and lifetime cap on rate increases, usually 2% increase/decrease annually and 5% increase lifetime cap from the initial rate. Pros, good for people who expect more income, want to move, or plan on paying it off in this fixed time period. Cons, you could end up with a high rate later and have a much larger payment.
We went with the typical adjustable rate mortage for a 7 year fixed period. I love our rate 4.25% with a lifetime cap of 5%, so the most we’ll ever pay is 9.25% if we stayed here forever. Our payments could potentially increase a maximum of $1200/month, which sounds like a lot, but not when other factors are involved. First the new payment would only be $750/month more than a 30 year/6% payment would have been. Second and more importantly, we chose the Arm because we knew we would be moving within 7 years. How did we know, well there were a few different reasons.
First when we bought this house with my husband and myself were just starting out after graduate school. That meant we were at our lowest salaries. There was tremendous potential for growth in our incomes. We knew our incomes would be rising and it has. Second, we bought the house based only on one salary not two, so it makes it pretty affordable with the double income. Third, we bought a townhouse which we hope to eventually be able to trade in for a single family home. Unfortunately we live in one of the most expensive cost-of-living areas in the US, so we were unable to afford a single family home for $500k or about twice the median single family home price in the US. Fourth, renting in such an expensive area was as much if not more than our mortgage without the tax benefit. This made the townhouse even more affordable with our incomes. Fifth, we know we’re going to move closer to families within the next 7 years and are determined to buy a single family home at that time, so this seemed like a good compromise. Thus with these reasons in mind we knew we were in an excellent position to buy the home with an Arm.
But what if we want to keep the home and rent it out? No we aren’t the landlording type, or else we would have kept our 1 bedroom condo as a rental instead of selling it. No we’re not really into real estate right now as an investment.
Finally our home is not an investment, it’s just a nice place to live without moving. So if we don’t earn much on it in the next 5-7 years, it’s okay. This way we’re paying minimal interest to borrow money for a very slowly appreciating asset. And we’re minimizing our potential losses, while maximizing our retirement and taxable accounts with cash in hand.