My FICO logo $$$$$$$$$$$ 9876 5432 1234 5678 CREDIT CARD KELLY SMITH 11/26 My FICO logo
SCORE
Skip Navigation
  • Why FICO
  • How It Works
  • Pricing
  • Education
  • Community
  • Support
  • Member Dashboard
  • Log In Log Out
  • Start Plan
 
  • Why FICO
  • How It Works
  • Pricing
  •  
  • Education
    • Credit Education
    • Credit Scores
    • What Is a FICO Score?
    • FICO Scores vs Credit Scores
    • FICO Scores Versions
    • New FICO Scores
    • How Scores Are Calculated
    • Payment History
    • Amount of Debt
    • Length of Credit History
    • Credit Mix
    • New Credit
    • How to Improve Your Score
    • How to Build Credit
    • Credit and Financial Counseling
    • Credit Reports
    • What's in Your Report
    • Credit Bureaus
    • Inquiries
    • Errors on Your Report?
    • Blog
    • Calculators
    • Loan Savings
    • Vehicle Payments
    • How Much Can I Borrow?
    • Should I Consolidate My Credit Cards?
    • Know Your Rights
    • Identity Theft
    • FAQ
    • Glossary
  • Community
  • Support
  • Member Dashboard
  • Log In Log Out
  • Our Products
    • Ongoing Credit Monitoring Track your FICO® Score & identity
    • One-time Credit Reports Be prepared for important transactions
  • How Can We Help
    • Monitor Credit & Identity
    • Mortgages
    • Credit Cards
    • Auto Loans
  • Credit Education
  • Community
  • Support
  • Our Products
    • Ongoing Credit Monitoring Track your FICO® Score & identity
    • One-time Credit Reports Be prepared for important transactions
  • Credit Education
  • Credit Scores
    • What Is a FICO Score?
    • FICO Scores vs Credit Scores
    • FICO Score Versions
    • New FICO Scores
    • How Scores Are Calculated
    • Payment History
    • Amount of Debt
    • Length of Credit History
    • Credit Mix
    • New Credit
    • How to Improve Your Score
    • How to Build Credit
    • Credit and Financial Counseling
  • Credit Reports
    • What's in Your Report
    • Credit Bureaus
    • Inquiries
    • Errors on Your Report?
  • Blog
  • Calculators
    • Loan Savings
    • Vehicle Payments
    • How Much Can I Borrow?
    • Should I Consolidate My Credit Cards?
  • Know Your Rights
  • Identity Theft
  • FAQ
  • Glossary

Estimate your FICO® Score range

Answer 10 easy questions to get a free estimate of your FICO® Score range

Estimate for Free

Get your FICO® Score for free

90% of top lenders use FICO® Scores

Get Access Now
No credit card required
View all Financing & Loans articles

6 Things to Consider Before Getting an Adjustable-Rate Mortgage

An adjustable-rate mortgage (ARM) might offer a lower initial rate than a fixed-rate loan. But here are six things to know before getting an ARM.

Photo by Pixabay on Pexels

Home buyers might be drawn to adjustable-rate mortgages (ARMs) when interest rates are high. These loans tend to start with a lower rate than the more common fixed-rate mortgages, which can lead to lower monthly payments and make buying a home more manageable.

With talk of interest rate decreases on the horizon, some buyers may also plan to start with an ARM and then refinance with a fixed-rate mortgage later. The approach might help you save money, but make sure you understand how ARMs work and the potential risks before opting for this route.

1. How Adjustable-Rate Mortgages Work

Adjustable-rate mortgages (ARMs) often have a 30-year term, similar to common fixed-rate mortgages. However, as the name suggests, the interest rate can change during this time.

The ARM's interest rate depends on an index rate, such as the Secured Overnight Financing Rate (SOFR), and a margin that the lender adds to the index. Your ARM's rate and your monthly payment can change when the index moves up or down.

However, your mortgage won't change every month. Instead, ARMs start with a temporarily fixed-rate period and then periodically readjust. These terms are included in the ARM's description.

You'll see two numbers, X/Y, in the ARM's name. The X is the initial fixed-rate period, and the Y is how often the rates adjust afterward. A 7/1 ARM has a fixed rate for seven years and then adjusts once a year after that, while a 10/6 ARM has a fixed rate for 10 years and then adjusts every six months.

There are various types of ARMs available, including options with fixed rates that last three, five, seven or 10 years.

2. The Initial Rate and Rate Caps

Compare your loan offers to see how your rates and resulting costs vary with an ARM and a fixed-rate mortgage. ARMs are riskier than fixed-rate loans because your rate and payments can increase, so an ARM might not make sense unless you can save money.

Additionally, review the ARM's interest rate caps, which determine how much the loan's rate can increase during the first adjustment, additional adjustments and overall.

For example, you might have a 7/1 ARM with a 5/2/5 cap. Your interest rate could change by up to 5% at the end of the initial seven years, and then it could change by up to 2% every year. The lifetime cap — the third number — tells you the maximum your rate could increase. There may also be a minimum that the rate can't fall below if the index drops.

3. How Long You Plan to Keep the Mortgage

If you refinance an ARM before the initial fixed-rate period ends, you'll never have to deal with the rate changing. Ideally, you can buy a home with a lower-rate ARM, wait until interest rates drop and then refinance into a less-risky loan with a fixed rate.

However, picking the right initial term can be tricky. ARMs with a shorter fixed-rate period might offer the lowest rate, but you'll have to hope that rates drop quickly. A longer initial term might make sense if you're not feeling confident about rates changing, or if you plan to sell the home and move before the rate starts to change.

4. The Cost of Refinancing

Another factor that you need to consider is how much refinancing the ARM will cost. For example, if you save $200 a month on interest and it will cost $2,400 to refinance, you might want to wait at least 12 months before refinancing.

There are two main costs to consider:

  • Closing costs. Your closing costs can depend on where you live, the loan amount and the lender, but it may be around 2% to 6% of the loan amount. Shop around and get several offers to see who offers you a loan with the best terms and lowest fees.
  • Prepayment penalties. Some ARMs might charge you a fee if you pay off the loan within the first several years. Look for an ARM without a prepayment penalty if you plan on refinancing.

Use the monthly mortgage payment calculator to see how much an ARM might save you, and compare the results to the potential cost of refinancing.

5. What Happens if Interest Rates Don't Drop

Interest rates might be higher than in recent years, but that doesn't mean they're destined to drop. If you're considering an ARM, think through what you'll do if interest rates increase.

For example, calculate what your payment would be if the rate increases to the ARM's lifetime cap. You could lose your home if you can't afford the higher payment, which might be a bigger risk than you want to take on.

Keep in mind, rising interest rates could coincide with other factors that make paying your mortgage or selling your home more difficult.

6. Your Eligibility for Refinancing

Similar to getting a mortgage to buy a home, your eligibility could depend on your income, employment history, debt-to-income ratio, home equity and FICO® Scores. And even if you can easily qualify for a mortgage today, your plan could go awry if you have trouble refinancing later.

Some of these factors might be outside your control, such as a layoff or medical emergency. However, if you plan on taking out other large loans or leaving your job and starting a business, that might make refinancing more difficult.

Get Your Credit Ready

An excellent FICO® Score can help you qualify for the lowest rates when you buy a home and refinance your mortgage. Review your credit and see if there are any ways to improve your FICO Scores, such as paying down revolving credit card balances. You may also want to avoid applying for other loans or credit cards in the months leading up to your mortgage application.

Get your FICO® Score from FICO, for free. No credit card required.

Image of Louis DeNicola

Louis DeNicola

Louis DeNicola is a finance writer based in Oakland, California. He specializes in consumer credit, personal finance, and small business finance, and loves helping people find ways to save money. In addition to FICO, Louis works with a variety of financial services firms, credit bureaus, and educational websites, including LendingTree, Credit Karma, and Experian.

Estimate your FICO® Score range

Answer 10 easy questions to get a free estimate of your FICO® Score range

Estimate for Free

Get your FICO® Score for free

90% of top lenders use FICO® Scores

Get Access Now
No credit card required

Page footer

Products

  • Home
  • Why FICO
  • How It Works
  • Pricing

Learn

  • Education
  • Community
  • Support
  • Blog

Company

  • About Us
  • Terms of Use
  • Cookie Preferences
  • Privacy Policy
  • Affiliate Program
  • Accessibility

Get Our App

  • Download iOS app on the App Store
  • fil_get
    Get Android app on the Google Play Store

Follow Us

  • Twitter
  • Facebook
  • Instagram

Credit Education

  • Credit scores
  • What is a FICO Score?
  • FICO Score versions
  • How scores are calculated
  • Payment history
  • Amount of debt
  • Length of credit history
  • Credit mix
  • New credit
  • Credit reports
  • What's in your report
  • Bureaus
  • Inquiries
  • Errors on your report?
  • Calculators
  • Know your rights
  • Identity theft
  • FAQ
  • Glossary

Copyright ©2001- Fair Isaac Corporation. All rights reserved.

IMPORTANT INFORMATION:

All FICO® Score products made available on myFICO.com include a FICO® Score 8, and may include additional FICO® Score versions. Your lender or insurer may use a different FICO® Score than the versions you receive from myFICO, or another type of credit score altogether. Learn more

FICO, myFICO, Score Watch, The score lenders use, and The Score That Matters are trademarks or registered trademarks of Fair Isaac Corporation. Equifax Credit Report is a trademark of Equifax, Inc. and its affiliated companies. Many factors affect your FICO Scores and the interest rates you may receive. Fair Isaac is not a credit repair organization as defined under federal or state law, including the Credit Repair Organizations Act. Fair Isaac does not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit record, credit history or credit rating. FTC's website on credit.