How Do Adjustable Rate Mortgages Work?

An adjustable rate mortgage is a home loan payment schedule whose interest rates fluctuate over time.  In other words, a borrower might be required to pay back different amounts every month depending on the prevailing interest rate at that time.

What Are Some Advantages of Adjustable Rate Mortgages?

With adjustable rate mortgages, borrowers can pay back principal (capital) early, without any type of penalty.  Thus, when interest rates are low, it becomes easier to chip away at the outstanding principal, and thus, pay off the loan in full much more quickly.

What Are Some Disadvantages of Adjustable Rate Mortgages?

If interest rates rise, it becomes much more difficult to pay off adjustable rate mortgages.  In the United States, interest rates fluctuate quite often, so homeowners should explore certain protections before taking out an adjustable rate mortgage.  Some lenders offer an initial period with a fixed rate.  Others have a maximum rate cap for any given year.  Others have a maximum rate cap over the lifetime of the mortgage. 

Without these special protections in place, it's very possible that a homeowner might get locked into a mortgage that becomes almost impossible to pay off during the initial lifetime of that loan.

Is an Adjustable Rate Mortgage Right for Everyone?

Most potential homeowners who have done their research tend to shy away from adjustable rate mortgages.  Unless there are telltale signs that interest rates will go down (and stay down), adjustable rate mortgages are usually not very attractive for the borrower.

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