What Is An Adjustable Rate Mortgage?

An Adjustable Rate Mortgage, or an ARM, is a mortgage that has an interest that can and will change over the term of the loan. Unlike fixed-rate mortgages that have an interest rate locked in for the life of the loan, the interest rate on an ARM will change periodically based on the margin, index, and set-up of the loan term. The initial interest rate of an ARM is often lower than that of a fixed-rate mortgage, which is advantageous in most cases. Consequently, and as a result, an ARM maybe a good option to consider if you plan to own your home for only a few years, if you expect to refinance in a few years, or if you expect an increase in future earnings. Also, another item to consider is whether the prevailing interest rate for a fixed mortgage is too high or out of reach when compared to the interest rate of an ARM.

Who Are Adjustable Rate Mortgages Best For?

An ARM is often logical for those looking to only live in their subject home for a short period of time, which makes an ARM a rational decision being that the rates are usually lower during the initial period. Secondly, an ARM may be logical for those who anticipate higher earnings in years to come, allowing them to refinance out of an ARM as their income increases and their finances allow for a higher, fixed-rate mortgage.

How Does An Adjustable Rate Mortgage Work?

The interest rate is fixed for a specific period of time. After that period – whether one year or three years or another term –the interest rate may change periodically depending on the market as well as the index and the margin. That means the monthly mortgage payment can go up or down each year. There are limitations known as ‘caps’ that will prevent the rate from increasing more than 5% of the original rate throughout the life of the loan.
Some of the more popular ARM options are a 5/1 Adjustable Rate Mortgage, 7/1 Adjustable Rate Mortgage, or a 10/1 Adjustable Rate Mortgage, where the rate is either fixed 5 years, 7 years, or 10 years, respectively.

Adjustable Rate Mortgage Benefits

  • Your monthly payments will generally be lower than fixed-rate mortgages during the initial term and before they adjust. Your initial/starting interest rate is typically lower than other kinds of mortgages.
  • Monthly mortgage payments are more affordable during the first years before the adjustment kicks in, making an ARM ideal for certain scenarios (e.g. short-term ownership of a home, high earning income potential, etc.).
  • Down payments can be as low at 5% on a home loan purchase .
  • Refinance up to 95% of the property value.
  • Larger purchase price possibly through lower rate.

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