With the Federal Reserve cutting its benchmark rate, some homebuyers may wonder whether mortgage rates will follow — and whether an adjustable-rate mortgage could offer a cheaper way to get into a home.
On Wednesday, the central bank lowered the federal funds rate to a range of 3.50% to 3.75%, the lowest it’s been since 2022. While the rate cut will reduce the cost of borrowing for credit cards and certain loans, it only indirectly affects new mortgages, which tend to follow movements in Treasury yields.
Even so, rate cuts and expectations of continued easing can put downward pressure on Treasury yields, which can in turn influence mortgage rates. Mortgage rates have generally trended lower since the Fed began cutting rates in September 2024, though there have been some bumps along the way.
That’s where adjustable-rate mortgages come in, since they often offer lower monthly payments initially than fixed-rate loans.
Adjustable-rate mortgages can be cheaper upfront
ARMs offer a fixed interest rate for several years before switching to a rate that resets periodically based on market conditions. That introductory period — usually three, five, seven or 10 years — is what generally makes ARMs cheaper upfront than traditional fixed-rate mortgages.
A 7/6 ARM — one of the more common mortgages on the market — stays fixed for seven years before adjusting every six months, for example.
As of Wednesday, the average 30-year fixed mortgage rate is about 6.36%, compared with roughly 6.06% for a 7/6 ARM, according to Mortgage News Daily. Over the last two years, the introductory ARM rate has typically run 0.3 to 0.5 percentage points below a 30-year fixed loan, a gap that can add up to thousands of dollars in interest savings over the fixed period.
While an ARM can work for borrowers with short- or medium-term plans, it can come with risks for anyone who expects to stay in their home long term or who prefers steady mortgage payments, says Benjamin Schieken, a mortgage professional and CEO of Fincast.
“An ARM can be a smart way to make a mortgage more affordable in the short term, but it’s not something to jump into blindly,” he says. “Borrowers should take the time to understand the terms, run the numbers and make sure they can handle the payment no matter what happens to rates.”
What to consider before choosing an ARM
The obvious tradeoff with an ARM is uncertainty after the introductory rate expires. Once the fixed period ends, the rate adjusts based on a benchmark — commonly the Secured Overnight Financing Rate — plus a fixed margin, which means your payment can rise if broader rates rise.
One protection for borrowers is that ARMs come with caps that limit how much the rate can increase. These limits apply at the first adjustment, at each subsequent reset and over the life of the loan. In practice, the rate can rise at every reset, but only by the amount allowed in the contract. The lifetime cap sets the absolute maximum the rate can ever reach, no matter how high broader market rates go.
But ARMs can be structured in different ways, and the terms vary from lender to lender. To avoid surprises, the Consumer Financial Protection Bureau and mortgage experts recommend taking a few key steps before choosing one. Buyers can also speak with a mortgage lender or another trusted financial professional for help understanding how these terms apply to their own finances.
1. Make sure an ARM fits your situation
ARMs generally work best for borrowers who have clear plans to move or refinance before the fixed period ends, says Bhavesh Patel, consumer channel executive at Chase Home Lending.
A borrower should be “comfortable taking a risk that interest rates may go up or down in the future,” he says. “An ARM isn’t a good idea if you plan to be in the home for a long period of time or think rates in the future could be higher.”
2. Understand the rate caps and how high payments can go
Some ARMs reset annually, while others reset every six months. More frequent resets mean the payment can change sooner, but each increase is still limited by the caps in your contract.
Review the caps for the first adjustment, which are often larger, as well as the caps on later adjustments and the lifetime maximum, which is typically about five percentage points above the starting rate, according to JPMorgan Chase Bank.
If the adjustments or the lifetime maximum would strain your budget, that’s a sign an ARM may not be the right fit, says Schieken.
“You want to be sure you can comfortably afford the maximum payment,” he says. “Don’t forget to factor in that taxes, insurance and HOA dues will probably go up over time,” as well.
3. Check if there are pre-payment penalties
A prepayment penalty is a fee some lenders charge if you pay off your mortgage early — typically by refinancing or selling the home — during the first few years of the loan.
These penalties typically run 1% to 2% of the outstanding balance if you refinance or sell within the first one to three years, per Bankrate. Some lenders use a step-down structure, such as 2% in the first year and 1% in the second.
Most standard mortgages don’t have prepayment penalties, but they can appear in certain loans from private lenders. They matter for ARM borrowers because it’s common to refinance or sell before the rate resets, and a penalty can make that move more expensive.
On a $400,000 mortgage, a 2% penalty would cost $8,000, which could outweigh the savings of choosing an ARM in the first place.
Lenders are legally required to disclose any prepayment penalties, and the details should appear in your loan estimate or other disclosure documents, Bankrate reports.
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