Adjustable Rate Mortgages or ARMs typically allow borrowers to make smaller payments during an initial fixed-rate period. The rate later fluctuates, or adjusts, dependent on market interest rates. If you are considering to own your home for only a few years or expecting your income to grow in the future, an ARM may be a good option to consider if a fixed-rate mortgage interest rate proves to be too high. The most standard plan is the five-year ARM, where the initial fixed-rate remains for five years before the first adjustment. But, you have options.
There are various ARMs available, each with different terms. Several of the more common types include:
3/1 ARM. A lower fixed interest rate for the first 3 years, with yearly adjustments after that.
5/1 ARM. A lower fixed interest rate for the first 5 years, with yearly adjustments after that.
7/1 ARM. A lower fixed interest rate for the first 7 years, with yearly adjustments after that.
Generally, the shorter the fixed rate period, the lower the interest rate. In the loans noted above, the 3/1 ARM will offer you the largest initial savings.
Consider this loan if you
Are mobile and plan to move before the end of the introductory fixed-rate period
Expect a raise or increase in income in the near future
Understand the product and are comfortable with its risks
Lowest available rates
Questions to ask yourself about ARM loans
Will my income increase enough to cover higher mortgage payments if interest rates go up?
Will I be incurring other sizable debts, such as a loan for a car or school tuition, in the near future?
How long do I plan to own this home?
Can my payments increase even if interest rates generally do not increase?
What you need to know
ARMs are considered risky because of potential interest rate hikes after your fixed-rate period ends. But, because you receive some of the most competitive rates upfront, you may be able to afford a larger home or put even more money in your pocket each month should you use an ARM to refinance. Just be sure to understand you may be susceptible to an adjustment increase thereafter.
The adjustments are based on a set of indexes defined in the loan agreement. When it comes time to adjust the rate, the lender adds a margin to the current index value to calculate the borrower's new interest rate. But wait, what about the risk? Well, borrowers are protected by industry caps, which limit the frequency of change, the periodic change from one adjustment to another, and the total change in interest rate over the life of the loan.
If your ARM is getting ready to adjust and increase, you may want to consider refinancing. Whether you move forward with a conventional loan, ARM loan, or utilize one of the many government programs, complete your research and ensure you have obtained the best rate and terms. Doing this could save you hundreds every month.
With so many options for adjustable rate mortgages, and even fixed-rate mortgages, American Financing's dedicated mortgage consultants can help you decide if an ARM is right for you, and if so, what type to choose.