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When Does an Adjustable-Rate Mortgage Make Sense?

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When you’re shopping for a mortgage, the rates you’ll see quoted for adjustable-rate mortgages look awfully tempting. In nearly every case, they’ll be significantly lower than a standard 30-year fixed-rate mortgage.

That’s because these rates only apply for a short period of time — typically going up significantly after a period with that lower rate.

However, adjustable-rate mortgages have their uses. Below, we argue for the two instances when it makes sense to borrow an ARM for a home purchase: if you’re planning to pay off your loan quickly, or if you plan to sell your home before the fixed-rate period ends.

What makes an ARM different?

An adjustable-rate mortgage is a home loan that has an interest rate that changes multiple times over the term of the loan, which is usually 30 years. That’s different from fixed-rate mortgages, where the interest rate stays the same for the entire period.

Most ARMs begin with a fixed interest rate for a period of five or seven years. Once the fixed-rate period ends, the interest rate becomes variable and adjusts periodically.

You can easily see how long the initial fixed rate period will last by looking at how the loan is marketed. If you borrow a 5/1 ARM, for example, your interest rate would be fixed for five years and then adjust annually thereafter for the remaining 25 years of the mortgage term.

The new, adjustable rate is partly determined by an index, which is a broad measure of interest rates. Some ARMs come with interest rate caps, meaning there’s a limit to how high the rate can adjust.

Because an ARM typically has a lower rate than a fixed-rate mortgage — for the first few years, at least — it can help you buy a home and start paying down your mortgage at a lower monthly cost than you could manage with a fixed-rate mortgage.

Let’s take a look at the cost differences between a 30-year fixed-rate mortgage and a 5/1 ARM during the first five years.

 30-year fixed 5/1 ARM

Loan amount

$200,000 $200,000

Interest rate

3.82% 3.51%

Monthly payment
(Principal and interest)


$934.19 $899.21

Principal paid after 5 years

$4,327.55 $4,499.45

Interest paid after 5 years

$6,882.77 $6,291.02

As shown above, the 5/1 ARM is less costly over the first five years of the mortgage term. Due to having a lower interest rate, you could save nearly $35 on your monthly payment and nearly $600 in interest. You’d also pay down just over $170 of your outstanding principal balance.

What to expect after the first adjustment

Your lender may have a limit in place for how much your interest rate can increase when it adjusts for the first time after the fixed-rate period ends. The initial adjustment cap could be 2% or even 5%, according to the Consumer Financial Protection Bureau.

Based on the example above, a 2% interest rate bump would push the 5/1 ARM’s principal and interest payment from $899.21 to $1,136.83 — a monthly difference of $237.62. This drastic jump in the monthly payment amount could push the mortgage into an unaffordable territory.

Cases when an ARM makes more sense

Adjustable-rate mortgages don’t suit every homebuyer, but there are certain instances when they make more sense:

  1. When you plan to pay off your mortgage very quickly.
  2. When you’re planning to sell your home in a few years.

Getting rid of your mortgage at a rapid pace

An ARM’s lower initial interest rate can work in your favor if you have the means to pay off your mortgage in a much shorter time frame than what a 30-year term calls for.

That’s exactly what Meg Bartelt, CFP and founder of Flow Financial Planning, and her husband did when they bought their home. Although the couple’s cash was largely tied up in investments, they had enough to buy their home outright. Still, selling the investments for the home purchase would’ve pushed them into a much higher tax bracket and increased their tax burden.

“By taking an ARM, we can spread the sale of those investments out over five years, minimizing the income increase in each year. That keeps our tax bracket lower,” Bartelt said. “We avoided increasing our marginal tax rate by double digits in the year of the purchase of our home.”

Another reason the ARM also worked in her family’s favor was the fact that they could continue to pay the mortgage past that initial five years if they chose to do so. “The interest rate won’t be as favorable as if we’d initially locked in a fixed rate,” she admitted, “but that option still exists, and having options is power.”

Selling your home before the rate adjusts

Another way ARMs can provide benefits to homeowners? If you won’t live in the home for long. Buying the home and then selling it before the initial fixed-rate period expires could provide you with a way to access the lowest possible rate without having to weather the eventual rise in your mortgage payment. When the interest rate adjusts, it’s more likely than not that it will significantly increase.

“ARMs are typically best for those who are fairly certain they won’t be in the house for a long period of time,” said Cary Cates, CFP and founder of Cates Financial Planning. “An example would be a person who has to move every two to four years for their job.”

His suggestion is to view an adjustable-rate mortgage as a way to pay “tax-deductible rent” — if you already know you don’t want to stay in the house for more than a few years.

“This is an aggressive strategy,” Cates explained, “but as long as the house appreciates enough in value to cover the initial costs of buying, then you could walk away only paying tax-deductible interest, which I am comparing to rent in this situation.”

You’re obviously not actually paying rent, but you can mentally frame your mortgage payment that way, Cates added. However, the risk is owing the difference between what your home sold for and your outstanding mortgage balance, if your home’s value hasn’t appreciated enough to cover what you spent to buy it.

Pros and cons of an ARM

ARM benefits ARM drawbacks
  • Interest rates typically start out significantly lower than fixed-rate mortgages
  • Lower initial principal and interest payments
  • You can more quickly pay down your principal during the fixed-rate years
  • Will typically include a cap on how high your interest rate can go when it adjusts

  • The interest rate isn’t predictable after the fixed-rate period ends
  • Influenced by market conditions even after they’re first borrowed
  • Your principal and interest payments can increase dramatically, causing your mortgage to be unaffordable
  • The only way to get rid of an ARM (outside of paying it off) is to refinance or sell your home

“The main advantage of an ARM is the low, initial interest rate,” Bartelt said. “But the primary risk is that the interest rate can rise to an unknown amount after the initial fixed period of just a few years expires.”

Homebuyers can enjoy extremely low interest rates for one, three, five, seven or 10 years, for example, depending on the term of their adjustable-rate mortgage. But borrowers have no control over the interest rate after that period.

When the index that the ARM is tied to rises, so does your interest rate. The rate could rise to levels that make your monthly mortgage payment unaffordable.

The variable nature of the interest rate makes it difficult to plan ahead, as the principal and interest portion of mortgage payment will no longer be stable.

“Imagine at the end of year five, rates start going up and your mortgage payment is suddenly much higher than it used to be,” said Mark Struthers, CFP, CFA and founder of Sona Financial.

“What if your partner loses their job and you need both incomes to pay the mortgage?” Struthers asked. In this situation, you could be stuck if you don’t have the credit score to refinance and get away from the higher rate, or the cash flow to handle the extra cost. “Once you get in this spiral, it is tough to get out,” he said. “The spiral just gets tighter.”

It’s easy to assume that you’ll be able to refinance into a fixed-rate mortgage before your first rate adjustment, but remember that just as you had to qualify for your original mortgage, you’ll again need to meet the qualifications to replace that loan with a brand-new one.

Read our explainer for a thorough rundown of how to refinance your mortgage.

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Questions to ask before borrowing an ARM

Before applying for an adjustable-rate mortgage, be sure to reach out to multiple lenders and ask questions like:

  • How long is the initial fixed-rate period? How does that compare with another mortgage option, and is it worth taking on a riskier mortgage to get the initial fixed rate?
  • How often will the ARM adjust after the initial fixed-rate period?
  • Is there a limit to how low the interest rate can drop?
  • How high can the interest rate go? How does that affect the monthly mortgage payment?
  • If the mortgage hits the maximum interest rate, would I still be able to comfortably afford the monthly payment, based on my debt-to-income ratio?

The bottom line

Borrowing an adjustable-rate mortgage may seem like a feasible idea, especially when you consider how much you can save during the early years of your mortgage. But it’s critical to consider whether the benefits outweigh the risks.

If you’re concerned about affordability, be sure you’ve developed a plan to refinance your mortgage or sell your home before the interest rate begins adjusting. Still, depending on your specific situation, your finances and your plans for the first few years following your home purchase, you could make an ARM work for you.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kali Hawlk
Kali Hawlk |

Kali Hawlk is a writer at MagnifyMoney. You can email Kali at [email protected]

Crissinda Ponder
Crissinda Ponder |

Crissinda Ponder is a writer at MagnifyMoney. You can email Crissinda here

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Target REDcard Credit Card: A Good Deal If You Know How to Use It

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When the words “retail store branded credit card” (or some variation of the phrase) are uttered, your response should be to turn and run. Store cards are notorious for being “bad” financial products for a variety of reasons.

The incentive that’s meant to rope you in – like 10% of your purchase – is temporary; the interest rates on the cards are upwards of 20%; the minimum payments are incredibly low, which encourage people to maintain high balances that rack up that nasty amount of interest; and many come with hidden fees (or just high fees) that can cost you even more money.

But there’s one store card that might offer a slight exception to the rule that says avoid store credit cards at all costs: the Target REDcard™ Credit Card. Let’s take a look at this card to see if it can benefit frequent shoppers – or if it’s just another credit trap waiting for uneducated consumers.

How the REDcard Works

The Target REDcard™ Credit Card offers shoppers 5% off in the form of an instant discount on every purchase made in stores or online (some restrictions apply). It’s a store branded card that does not have an annual fee – or a complicated rewards program, as again, the reward is given immediately upon purchase. The card can only be used at Target stores and Target.com.

Target REDcard vs. Target Prepaid REDcard

The Target REDcard™ Credit Card is a regular credit card, not to be confused with Target's prepaid REDcard product.

A prepaid card is loaded with funds each month by the user who can then use those funds as they wish, like a regular debit card. Most people use prepaid cards as a budgeting tool or as an alternative to a checking account. Prepaid cards do not factor into your credit report and, as a result, have no impact on your credit score.

With a credit card, you are borrowing funds from a bank and must pay them back each month or face penalties, fees, and a likely hit to your credit score.

What Do You Get with a REDcard? 

The best thing about a Target REDcard™ Credit Card is that you get your 5% at Target & Target.com discount at every checkout, no gimmicks or strings attached. It applies to everything you can buy in the store, including items already marked down or on sale, and you can use it while applying other coupons to your purchase.

The exception is that you will not receive 5% off the following purchases:

  • Prescriptions, over-the-counter items located behind the pharmacy counter and clinic services at Target
  • Target Optical™ eye exams
  • Target gift cards and prepaid cards, and Stockpile and Gift of College gift cards
  • Certain restaurant merchants in Target stores, such as D’Amico & Sons Italian Kitchen and Pret A Manger
  • Gift wrap and shipping and handling charges on Target.com purchases
  • Wireless protection program purchases and deposits required by a mobile carrier

In addition to the 5% discount, you’ll receive free shipping on any purchase online, an added benefit if you’re an online shopper.

There are no points to earn and redeem, no statement credits to request, no hoops to jump through. Just straight-up 5% off on your purchase – and free shipping if you’re shopping Target.com.

The Pitfalls of Target’s REDcard You Must Avoid

Of course, the benefits quickly evaporate should you make one tiny mistake with your Target REDcard™ Credit Card. The variable interest rate – at 25.15% Variable APR – is high, and makes the 5% savings completely inconsequential if you’re only paying the minimum.

Ultimately, despite the better-than-average perks, the Target REDcard™ Credit Card is a store branded credit card and comes with the typical pitfalls: high interest rate, high fees, low minimum payment requirement designed to encourage people to revolve balances.

Not to mention, most REDcards come with low limits since you can only use them at Target stores. This could hurt your credit utilization ratio – and therefore, your credit score as a whole – if you don’t have many other credit cards. Remember, credit utilization is based on your total credit limit, not per card.

If you’re just starting to build your credit, the REDcard’s 5% may not be worth the downsides of holding the card.

Fine Print

To sum up, here’s what you need to know before considering this credit card:

  • The REDcard grants you a 5% discount on nearly every purchase at Target and Target.com. This discount is immediate upon checkout, so it’s more like a guaranteed discount on your Target purchase than other forms of money back.
  • You’ll receive free shipping online at Target.com when you use your Target credit card.
  • The APR can be as high as 25.15% Variable.
  • Minimum payments are low, which encourages consumers to make small payments on balances over long periods of time – costing an incredible amount in interest fees.
  • Late payment fees run up to $38. Returned payment fees run up to $27.

If you miss a payment, are late on a payment, or only pay the minimum balance, your 5% savings will be automatically negated.

Only use the Target REDcard™ Credit Card if you have established a history of paying your balances in full and on time – and can manage your money so you only purchase what you budgeted for and truly need.

There’s also one more issue that consumers should be aware of, although whether it’s “good” or “bad” is probably a matter of personal preference. In the interest of full disclosure, however, we believe in making note of the fact that Target does use its branded store cards to collect data and information about you and what you buy.

In Conclusion

Target’s REDcard is a great financial product for people who frequently shop at the store for everyday purchases on necessary items like toiletries, household goods, school supplies, and clothing. There’s no annual fee and the automatic 5% discount is an excellent way to save even more money when you do your regular shopping.

However, there are big consequences for missing payments or getting trapped into revolving your balances month to month. The late payment and missed payment fees are high, and the variable interest rate is alarming at 24.15%.

You may want to avoid picking up this card if you’re not a normal Target shopper – and the promise of a “reward” will encourage you to spend money that you would not otherwise. And most certainly avoid this store card like you would any other if you struggle to manage your money and your credit.

Otherwise – if you’re experienced in managing your purchases and your credit, and already have good credit – the REDcard is a great option if you’re looking to save even more on necessary purchases and spending you already do.

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Target REDcard™ Credit Card

Annual fee
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Rewards Rate
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Regular Purchase APR
25.15% Variable

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kali Hawlk
Kali Hawlk |

Kali Hawlk is a writer at MagnifyMoney. You can email Kali at [email protected]

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Vacation Loans: Find the Lowest Rate Options

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Find the Lowest Rate Options

Updated November 03, 2017
Travel is a huge priority for many people in their 20s and 30s. Seeing the world and collecting those experiences can make a big impact on you as you continue to develop into the person you want to be, and it’s just easier to get out there and go when you’re young.

You have fewer responsibilities to tend to back home, and long-term relationships, houses, or children might not be tying you down.

But if you’re early on in your career and still dealing with burdens like student loan debt from your college days, you also have less money to spend on travel when you’re young. Money can be a major limiting factor in your ability to take vacations and see more of the world right now.

If you’re set on taking vacations even when your budget is limited, you may be tempted to look into loans to fund your trips.

Can You Get a Loan for Travel?

While “vacation loans” aren’t really a thing, you do have options if you look into getting a loan to fund a vacation. Many lenders will provide personal loans instead.

You can get a secured or unsecured personal loan. A secured personal loan means you put up some asset as collateral against the loan, so if you don’t repay the money you borrowed you lose that collateral. (That collateral is often something like your car.)

You may be able to borrow more at a better interest rate if your loan is secured, but you risk losing whatever asset you used as collateral.

When you apply for a personal loan, you’ll need to provide a reason for borrowing the money. Some institutions accept things like travel and vacations as legitimate reasons for borrowing. And while taking out a loan for your vacation may sound crazy, it could be a better financial option than loading up travel expenses on your credit cards.

Funding Vacations with Personal Loans

If you do an online search for personal loans to fund your vacation with, you’ll likely come across a number of lenders that offer funds for this purpose. SoFi, Prosper, Earnest, LendingClub, Karrot, and Upstart are all legitimate companies to explore if you want to take out a personal loan for travel.

These are all online loan companies that offer personal loans, along with other financial products. (SoFi, for example, offers student loan refinancing.) The amount you can borrow will vary depending on a number of factors. Karrot allows borrowers to request up to $35,000. Upstart’s minimum loans vary by state, but all max out at $50,000 as well. SoFi offers personal loans in amounts from $5,000 and $100,000.

Earnest is a little different. The company offers “merit-based” unsecured personal loans up to $75,000. These loans are designed for individuals who may have limited credit histories but demonstrate that they’re financially responsible.

There are a number of other companies that aren’t as reputable as those listed above, and are considered predatory. Predatory lenders tend to make loans with extortionate interest rates with complicated terms that are in favor of the lender, not the borrower.

You can quickly end up owing far, far more than what you initially borrowed if you’re not careful – especially when searching for a loan specifically to fund a vacation.

Again, there are no “vacation loans.” These loans are just personal loans, but marketed to be used for vacations. Predatory lenders target keywords like vacation loans and will often show up in search results if you look for a loan to fund your trip, so be aware of companies like Loans of America who create landing pages for their products like this. Choice Personal Loans is another example of a predatory lender that you should avoid.

But perhaps a loan shouldn’t even be your first thought.

The First Option to Consider

If you have excellent credit, then a 0% purchase APR credit card may provide you with a better option than a personal loan. The benefit of using these cards is that you’ll be able to pay off your vacation over time, with no extra payments to interest.

In addition to looking for personal loans, consider a balance transfer credit card. You can find MagnifyMoney’s guide to the best balance transfer credit cards here, which is updated regularly.

Keep in mind that most of these cards provide the 0% APR as a limited-time offer and there’s a time limit. If you fail to repay your balance in full by the end of that promotion period, you’ll owe interest on what you charged to the card. Not managing your payments can cost you a tremendous amount, so charge your vacation to any credit card with caution.

You could seek out a low interest rate credit card instead, but these typically come from credit unions and are reserved for the institution’s members. It’s well worth looking into this option if you’re a member of a credit union or are considering opening an account with one in your area.

If you are wary of charging your family vacation on a credit card or are concerned about paying it off before the end of the 0% APR, then look into personal loans.

If You Have to Borrow, Here’s What You Need to Know

If you choose to seek out a personal loan for a vacation, you need to have good to excellent credit to be approved – and to get a low interest rate on the money you borrow. Getting the lowest interest rate possible is the only way a personal loan might be a viable financial solution for your trip.

None of the lenders below charge a pre-payment penalty, but some do charge origination fees – so don’t forget to factor that in to the total cost.

Earnest (From 5.99% to 17.24% APR): One of the few lenders with No origination fee and no pre-payment penalty, Earnest is an excellent choice for those with top-notch credit and employment history. Fixed rate personal loans start range from 5.99% to 17.24% APR and you can borrow up to $75,000.

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SoFi (fixed APR 5.99% – 17.67% with autopay): Similar to Earnest, SoFi also charges No origination fee, no pre-payment penalty and allows you to check your rate without harming your credit score. You can borrow a minimum of $5,000 and up to $100,000 from SoFi.

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LightStream (3.99% – 16.99% APR with AutoPay): is another lender that has No origination fee, but their interest rates run higher with the lowest starting at 3.99%. Similar to SoFi, you can borrow a minimum of $5,000 and up to $100,000. Unfortunately, there is no soft pull option and it will be a Hard Pull on your credit report to check if you’re eligible and determine your rate.

Karrot (6.44%APR): Karrot’s minimum APR is a bit lower than LightStream, but the company does charge an origination fee. This fee varies from 1.05% - 4.75% of the total loan. Karrot’s APR cap is also significantly higher than Earnest, SoFi and LightStream – which means you could end up borrowing at a rate closer to 30% APR.

Note: Karrot has suspended their personal loan program and are not currently offering new personal loans at this time. If you have an outstanding personal loan, Karrot states they are still servicing those accounts.

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Upstart (4.73% – 35.99% APR): Similar to Karrot, Upstart also charges an origination fee and has a higher maximum APR cap of 35.99% APR. The origination fee is a up to 8.00% APR on a loan up to $50,000. You can check your rate without it affecting your credit score.

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Be sure to shop around and get quotes from a number of companies, and then compare rates.

What to Do If You Have Poor Credit

The most difficult part of getting a personal loan from a reputable company for any purpose is getting approved as a borrower. Most companies require good to excellent credit scores before they’ll allow you to borrow funds.

But there are options if you have poor credit. Avant, One Main Financial, and FreedomPlus are lending options that are more lenient with borrowers. But beware: these loans will come with origination fees and much higher interest rates than what is available via companies like SoFi, Earnest, and Upstart.

Avant, for example, charges 9.95% to 35.99% APR on its loans. FreedomPlus’ loans come with an APR from 5.99% to 29.99%. Additionally, these products aren’t available in all states and rates may change depending on where you live. Avant branded credit products are issued by WebBank, member FDIC.

You can find more information on these companies by searching for their FAQ, Support, or Help pages. Before applying, you should understand all fees involved, whether or not you’ll be charged if you pay off your loan early, and what interest rates and APRs you’ll be charged.

Look into Alternatives to Borrowing Money

At the end of the day, getting a personal loan is an option for funding your vacation — but it may not be the best money move to make. Instead of borrowing money, whether through a loan or by charging costs to a credit card, make a plan to explore financially sound alternatives.

The best way to fund your travels is to create a plan and start a travel savings fund for the trip or vacation you want to take. Consider using banks that offer great interest rates on cash savings accounts, like the ones in this post all offering APY of 1.05% or higher.

Then plan your trip and get an idea of the total cost. Let’s say you want to take a trip in the next year or so and you know your vacation will cost you $5,000. By giving yourself 18 months to save, you can set a goal to transfer $278 per month to your travel savings fund.

That will allow you to pay for your trip yourself, without taking out loans or using credit cards and subsequently paying more in fees and interest charges.

Feel like you can’t wait that long for your vacation? Your next option is to look at how you can reduce costs and take a trip that fits in your budget right now. Some solutions may include taking a trip with other people and splitting the cost of things like accommodations, or looking for low-cost alternatives to your dream trip. Perhaps you can stay in hostels or use Airbnb to find cheap rooms instead of splurging at pricey hotels every night.

And you can still use credit cards in a smart, responsible way. You can maximize your current spending and rack up reward points for travel. Then, you can use those rewards and points to cover your vacation expenses instead of paying for all costs with cash.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kali Hawlk
Kali Hawlk |

Kali Hawlk is a writer at MagnifyMoney. You can email Kali at [email protected]