By accepting an adjustable interest rate for the term of your loan or mortgage, you are also taking on a degree of interest rate volatility risk, so you may receive additional benefits such as lower initial payments. Is this a good strategy for you and your family?
While the home purchasing vehicle called an adjustable rate mortgage is very popular and does have some financial benefits, there are also some potential dangers and pitfalls to having an adjustable interest rate on your mortgage.
Ironically, despite tough economic times, one of the best times to take advantage of an adjustable rate mortgage can be in the period coming out of a recession when the market and economy as a whole is in an uptrend, because this is the time when lenders are more willing to negotiate rates.
When Is A Good Time For An Adjustable Rate?
When a financial institution or lender offers a fixed rate mortgage to a home buyer, they are taking a risk by betting on the fact that interest rates will not sharply increase during the lifetime of the loan period. If interest rates do go up, they will be locked into a low fixed rate when they could be earning more if it was adjustable.
Conversely, if interest rates are projected to go lower during the lifetime of the loan then this would be a good scenario for the lender and bad for the borrower because they would be stuck at their higher fixed interest rate.
So how do you decide whether now is a good time to go with either a fixed rate or an adjustable rate? Simple: do you project that over the lifetime of your mortgage (usually 5-30 years) interest rates will go up or down?
If they are going to go up, you should get a fixed interest rate to shield yourself from this added risk. If you think they are going to go down, you might want to consider an adjustable rate mortgage so that the interest you pay back can decrease as the overall interest rate decreases.
However, keep in mind that an adjustable rate can always go the other way and you can end up paying back more interest than if you had agreed upon a fixed level.
Why Would a Bank Offer An Adjustable Rate Mortgage?
One of the risks of being a lender and agreeing upon interest rate conditions is that there is always the unknown future volatility that can make interest rates go either up or down. With that idea in mind, your bank would be taking a risk by offering a low fixed rate to you for your loan.
By accepting an adjustable interest rate for the term of your loan, you are also taking on a part of that risk an so you may receive additional benefits such as lower initial payments.
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