A mortgage where the interest rate changes can be called an adjusted rate mortgage or ARM, a variable rate mortgage or a tracker mortgage but they are all essentially the same type of mortgage.
Variable home loan rates are what makes all of these different than a fix rate mortgage.
With the variable interest rate mortgage, the rate charged on the outstanding balance of the mortgage changes at given intervals based on the index which reflects the cost to the lender of borrowing on the credit. The potential fluctuation in interest does represent a bit of a risk but there are very specific cases when a variable rate is a very smart choice.
A Short Term Purchase
If you are buying a home and are only planning to stay in the house for a few years, say between three and five years, then an adjustable rate mortgage is ideal. The first reason that this is a good idea is that the initial variable rate is a lower interest rate than a fixed rate. Currently, the rates are about one point apart. This doesn’t sound like much but over the course of five years it can add up. For example, a home purchased for $200,000 with 20% down would cost around $745 per month with a fixed rate 30-year loan. The same purchase on a variable rate would cost $650 a month. So that would be a savings of around $6,000 over the five years. In addition, you would be paying down your principal by an additional $2,700 so the total savings in five years would be over $8,000. This can be a big difference in equity and in monthly mortgage payments if you know that you will not be staying beyond the duration of the initial interest rate.
A Purpose for Short Term Home Buying
You might ask why someone would buy a home knowing that they are only staying for a few years but there is one very good reason for this. If you are buying a fixer upper as an investment then you will live there until the project house is completed and then you want to sell it to get your sweat equity back out of the house. In addition, you are creating a smaller monthly mortgage and that gives you more money each month to use to renovate the home. So you pay more principal, you lower your monthly payments and then you flip the renovated house for a tidy profit. And you do this knowing that because the house was also your primary residence then you are not going to need to worry about capital gains tax on the profit unless the profit is in excess of $250,000. So variable home loan rates can be very good for an investor.
You Expect to Earn More
An adjustable rate mortgage is also a good idea if you believe that your income is going to increase over the length of the initial interest term. You can take advantage of the lower rate at first and then if the rate does increase you will still be able to afford the payment. Another option would also be to refinance the home at a fixed rate if you decide that you will not be selling the home. So either way that lower rate to start off the mortgage is a great way to get into a house with a lower payment.
The Young Professional Scenario
Another reason that many younger home buyers are selecting a variable rate loan for their first mortgage is to pay off student loan debt. Often time’s graduates are facing several years of student loan debt but they also want to purchase a home and begin that stage of their life as they begin their career. No one wants to get their first real job in their career only to begin throwing away a chunk of that hard earned money on rent. Buying a first home is a smart investment in the future and it also offers some great tax benefits. So thanks to variable home loan rates and a lower mortgage for the first few years, homeowners can pay off student loans and then afford the increase in their mortgage when the rate changes. There are also other reasons that you might need that lower mortgage payment for the first few years. You might be paying off credit card debt or completing the payments on your vehicle, but after those debts are paid then you will be able to devote that portion of your monthly income to your mortgage payment.
Just To Create an Emergency Fund
When you buy your first home, you might not have had the opportunity to create much of a savings for unexpected expenses but you know that they can always pop up. So by having a variable rate mortgage for a few years you are using that time to save the money that you would have been spending on a higher mortgage payment each month. This lets you create a nice savings account and at the same time you are making regular mortgage payments and that is improving your credit. So when you are nearing the five year term of the initial interest rate you will be in a great place to refinance your mortgage to a fixed rate. You will have better credit, you will have equity in the home and you will have a nice savings account that you can fall back on if you have an unexpected expense.
Know the Terms
Every loan or mortgage has slightly different terms and it is up to you as the borrower to educate yourself about variable home loan rates. And if this type of loan affords you the opportunity to get into your first home and keep your mortgage costs low for a few years then it could be a great choice for you. Be sure to read the loan document carefully and be sure that you understand all of the terms and then enjoy the benefits of a variable rate mortgage.