Be Careful With ARM Prepayments

If you have an adjustable-rate mortgage loan, the option to make prepayments to the principal should be available to you. While most borrowers are allowed to make ARM loan prepayments, some loans do charge a penalty for early payments.

The Purpose of Making ARM Prepayments

The reason for making prepayments on an ARM is to lower the cost of the interest charged. The benefit lies in that once the mortgage rate resets, possibly to a higher one, the borrower will still get a lower monthly payment because there is a smaller principal balance. By paying down the principal fast, you’re also reducing the amount of debt you have sooner.

Drawbacks to Prepayments

However, depending on the terms of your loan, there could be extra fees or penalties associated with prepayment. Be sure to read the fine print of your loan agreement since these types of fees and penalties will vary from lender to lender. Prepayment penalties can be as high as several thousands of dollars, significantly affecting your total cost in financing your home purchase.

Advantages of Prepayments

While prepaying is available on most mortgage loans, one advantage with ARM loans specifically is to help soften the blow of a spiking rate reset. Most ARM loan borrowers usually experience a shock at the new, higher monthly payment they have to make because their rates shot up. By paying a large chunk of the principal earlier, monthly payments become lower because the time horizon for the full payment of the ARM loan remains the same.

If your mortgage loan charges a penalty fee for prepaying on the principal, you should evaluate whether or not that option is still cost effective. In some instances, the long-term savings from an ARM loan prepayment could outweigh the short-term penalties and fees that come with paying early. Consult a mortgage loan professional or lender to see what your best options are.