Adjustable-rate mortgages are home loans with an interest rate that changes over time. This type of home loan can be risky, but with a lower initial interest rate than fixed-rate mortgages, 5/1 ARMs can be a good option – especially if you plan to sell or refinance within a few years, before the lower interest rate adjusts.
In the current rate environment, some prospective homebuyers may be considering an ARM as an alternative to a traditional fixed-rate mortgage. For the first time since 2002, rates have risen past 7% for a 30-year fixed mortgage, and data from the Mortgage Bankers Association shows that ARM demand is the highest it’s been since 2008 – with about 13% of applicants choosing adjustable-rate mortgages as of October 2022.
That being said, there are a few things you should know about using an ARM to finance your home purchase. This guide can help you understand adjustable-rate mortgages and find the right lender for your homebuying needs.
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AmeriSave Mortgage Corp. is an online lender that has been in business since 2002. It was one of the first to offer an offsite digital mortgage experience for customers. The company says it has financed more than 664,000 borrowers since it began operating. With headquarters in Atlanta, AmeriSave services loans in 49 states and Washington, D.C.
Pentagon Federal Credit Union, widely known as PenFed, offers borrowers access to many types of mortgages: conventional, adjustable rate, jumbo and Department of Veterans Affairs, plus refinancing loans and home equity lines of credit. The financial institution, which serves 2.8 million members, was established in 1935 and is based in McLean, Virginia.
Best for low APR
New American Funding is a mortgage lender offering a variety of home loan options to homebuyers and homeowners nationwide except for Hawaii. The company, founded in 2003 and based in Tustin, California, has originated $64.2 billion in mortgages to date.
PNC Bank is one of the largest banks in the United States, serving more than 9 million customers in all 50 states. A full-service mortgage lender, PNC offers most mortgage loan product types.
Bank of America serves roughly 67 million customers in all 50 states. The lender offers conventional, Federal Housing Administration, Department of Veterans Affairs and jumbo loans as well as home equity lines of credit and mortgage refinancing.
Guaranteed Rate, founded in 2000 and based in Chicago, offers mortgage options including conventional loans, FHA loans, jumbo loans and interest-only loans to customers in all 50 states and Washington, D.C. Borrowers can take advantage of specialized loan products and Guaranteed Rate’s online application, documentation and loan payment options.
Wells Fargo offers a variety of mortgage products nationwide. Options include conventional, government-backed and jumbo loans. You can also refinance an existing mortgage with Wells Fargo.
SoFi is an online lender founded in 2011 and headquartered in San Francisco that offers fixed-rate mortgages. Refinance, jumbo and home equity loans are also available.
Best for customer service
Rocket Mortgage, the largest mortgage lender in the nation, was founded in 1985. The Detroit-based company is best known for its fully digital experience of buying or refinancing a home. Rocket Mortgage changed its name from Quicken Loans in the summer of 2021.
Chase, one of the world’s largest banks, was founded in 1799 in New York and offers fixed-rate, refinance and other mortgage loans.
Mortgage rates rose this week, with the average 30-year fixed rate jumping to 6.73% from 6.55% a week ago. Most fixed and adjustable rates are trending higher as the Federal Reserve tightens its monetary policy in response to mixed economic signals.
Mortgage interest rates are nearly twice as high as they were at the beginning of 2022, which continues to have a tangible impact on mortgage affordability and consumer housing sentiment. However, mortgage rates are widely expected to fall throughout the course of 2023. Here are the current mortgage rates, without discount points unless otherwise noted, as of Feb. 16:
- 30-year fixed: 6.73% (up from 6.55% a week ago).
- 20-year fixed: 6.77% (up from 6.62% a week ago).
- 15-year fixed: 6.02% (up from 5.75% a week ago).
- 10-year fixed: 5.97% (up from 5.77% a week ago).
- 5/1 ARM: 5.43% (up from 5.38% a week ago).
- 7/1 ARM: 5.7% (down from 5.81% a week ago).
- 10/1 ARM: 5.9% (up from 5.87% a week ago).
- 30-year jumbo loans: 6.78% (up from 6.59% a week ago).
- 30-year FHA loans: 5.98% with 0.06 point (up from 5.75% a week ago).
- VA purchase loans: 6.08% with 0.05 point (up from 5.86% a week ago).
An adjustable-rate mortgage is a home loan with an interest rate that changes over time. Unlike with a fixed-rate mortgage, which keeps the same interest rate for the life of the loan, your interest rate will change according to a benchmark rate. Typical loan terms are 15 and 30 years, but 10- and 20-year terms are also common.
The three most common types of ARMs are hybrid, interest-only and payment-option.
- A hybrid ARM is the most common type of adjustable-rate mortgage. It has an initial interest rate that remains fixed for a certain amount of time and then adjusts periodically afterward. So a 5/1 adjustable-rate mortgage has one rate for the first five years and, after that, adjusts every year. A 3/1, 7/1 or 10/1 ARM works the same way, adjusting annually after the initial fixed-rate period (three, seven or 10 years, respectively). However, if the second number is six, such as a 7/6, your rate may adjust every six months after the initial fixed period.
- An interest-only ARM only requires interest payments during the initial payment period. After that, the loan is amortized based on the remaining term, and the monthly payment increases substantially.
- A payment-option ARM allows the borrower to choose from multiple payment options. Usually, the options are standard principal and interest payment; interest-only payment; and limited payment. In the latter, the loan balance increases if you make only required payments.
Pros
- Start with lower rates. ARMs typically start with lower interest rates than fixed-rate mortgages.
- Possible to pay less in the future. If you’re buying a home while mortgage interest rates are high, an adjustable-rate mortgage may be preferable – because if market rates go down in the future, your mortgage rate will go down, too.
- Good for short-term purchases. If you’re only planning to keep your property or mortgage for a short period, an ARM provides lower payments for that duration.
- Fixed-rate conversion is possible. Convertible adjustable-rate mortgages allow you to have lower initial payments than a fixed-rate mortgage, while also allowing you to lock in a fixed rate after a period of time.
Cons
- Rates can increase. With an ARM, your mortgage rate may increase if the market rate increases – which could end up costing you more in the long run.
- Agreements and conditions can be complex. Adjustable-rate mortgages tend to have more conditions and complex agreements than fixed-rate mortgages, which can be riskier for borrowers.
An adjustable-rate mortgage is like any other mortgage: A lender pays a seller for the home you want to buy, and you make regular monthly mortgage payments to the lender until the loan is paid off. But unlike with a traditional fixed-rate mortgage, the interest rate changes periodically, per the terms in the loan contract.
Most adjustable-rate mortgages start with a competitive initial fixed-rate period, often with a lower interest rate than what’s available on fixed-rate mortgages. When the period ends, the interest rate changes at predetermined intervals, according to the benchmark rate the loan follows.
Your interest rate changes when your adjustment period ends. The lender can raise your rate if its fully indexed rate is higher than your current mortgage rate. If the benchmark rate goes down, the lender might lower its fully indexed rate and, accordingly, your rate.
Rate caps put a boundary on how much your interest rate can change. Caps can be periodic, which limits how much the rate can increase at each readjustment period. There is also a lifetime cap, which nearly all ARMs are required to have.
It’s important that borrowers examine their individual situations and decide whether or not an ARM is the best fit.
ARMS Can Be a Great Choice
An adjustable-rate mortgage offers a competitively low interest rate for those who can avoid or minimize the impact of a potentially rising rate in the future.
If you plan to sell the property or refinance before the first adjustment period or before future interest charges outweigh early interest savings, you could save money.
An ARM also can be a good option for first-time homebuyers who expect an income boost in a few years. For example, a military family on limited deployment or a medical student who will become a doctor might be a candidate for an ARM.
ARM Loans Are Not for Everyone
However, an ARM is not the best choice for every borrower because of the potential for rate increases over time. ARMs can be complex and terms can be difficult to understand, so borrowers should be fully familiar with their benefits and drawbacks before moving forward.
You may be surprised at how much the payment can increase in the future or at the challenges you could face in selling or refinancing the property. There are several ways to achieve negative amortization on an ARM, resulting in a loan balance larger than what you originally borrowed.
One selling point of ARMs is that, technically, the rate could go down. But because an ARM tends to start low, increases are typically inevitable.
Find the Mortgage That’s Right for You
The four key factors for choosing the best adjustable-rate mortgage lender are:
Product offerings. The best lender will offer products with the terms and features that meet your needs, whether that be conventional, FHA or VA loans.
Interest rates. A low interest rate can save you tens of thousands of dollars over the life of your loan. Even a fraction of a percent can drive significant savings – or costs.
You might want to discuss the pros and cons of various ARM options with the lender, including:
- 5/1 ARMs.
- 7/1 ARMs.
- 10/1 ARMs.
- Interest-only ARMs.
Closing costs. Lenders have some flexibility when it comes to many closing costs. Generally, lower upfront costs are associated with higher interest rates. If you are looking for a loan with as little out-of-pocket cost as possible, you may face higher costs overall and vice versa.
Customer service. As with any major purchase, find out what other customers say. You may be tied to this lender for years or decades, so choose one that has demonstrated an ability to provide good customer service.
U.S. News selects the Best Loan Companies by evaluating affordability, borrower eligibility criteria and customer service. Those with the highest overall scores are considered the best lenders.
To calculate each score, we use data about the lender and its loan offerings, giving greater weight to factors that matter most to borrowers. For mortgage lenders, we take into account each company’s customer service ratings, interest rates, loan product availability, minimum down payment, minimum FICO score and online features.
The weight each scoring factor receives is based on a nationwide survey on what borrowers look for in a lender.
To receive a rating, lenders must offer qualifying loans nationwide and have a good reputation within the industry. Read more about our methodology.
To recap, here are the picks:
5/1 ARM Lenders of February 2023
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