Suze Orman Says to Do This Before Getting an Adjustable Rate Mortgage

Listening to Orman's advice could save you from making a major mortgage mistake.

When you buy a home, you have to decide what type of mortgage to get. Home loans can be broadly divided into two types: fixed or adjustable rate loans. Each does exactly what it sounds like. Fixed-rate loans keep the rate fixed for the entire duration of your repayment period, meaning your rate and payments don't change. Adjustable rate loans adjust, which means the rate can change over time after an initial lock-in period.

Adjustable rate loans can seem like a good option if you need more affordable payments, because the rate generally starts lower than with a fixed-rate home loan. This means your initial monthly payments may be lower. It's important to think carefully about whether an ARM makes sense in your situation.

To help you make that choice, you may want to consider following some great advice from financial expert Suze Orman.

What Suze Orman recommends before choosing an ARM

Orman acknowledges on her blog that many people may be attracted to adjustable rate loans because of their low starting rates. This is especially likely when mortgage rates have been trending up, as they've been doing in recent months.

However, she says before you take out this type of loan, "you must think about the ‘what if’ scenarios after the initial period expires."

See, each ARM comes with an initial lock in period. For example, a 5/1 ARM would have the starting rate locked in for the first five years, while a 7/1 ARM would have it locked in for the first seven years. But Orman stresses looking beyond this limited time when your rate is guaranteed -- especially if you plan on remaining in the home for many years.

The big problem is, if rates are higher at the time when your loan begins adjusting, you could see your rate go up -- perhaps substantially. Depending on your loan, Orman points out that rates could go up as much as 2 percentage points annually and as much as 6 percentage points over the life of the loan.

Borrowers with fixed-rate loans don’t have to worry about their rates changing

This could lead to a significant increase in your rate, monthly payment, and total loan costs. By contrast, someone who chose a fixed-rate loan would not have to worry about rates changing. Even if rates rose dramatically, a borrower with a fixed-rate loan would still have the same starting rate and mortgage costs.

Since rates are still low by historical standards, even as they have climbed from record lows during the heart of the pandemic, there's a good chance rates will climb higher by the time your ARM begins adjusting. This means it's especially important for borrowers to follow Orman's advice and consider the worst-case "what-if" scenarios about how high their interest rate could go.

If you find that you may not be able to afford the higher rates in the future -- or don't want to take a chance of paying more in interest over time -- then opting for a fixed-rate loan could end up being a better choice.