An adjustable rate mortgage, also known as an ARM, has both benefits and drawbacks to consider before choosing an ARM to finance your home. Before you choose, learn what an ARM loan is, the different types and if it is the right loan for your situation.
This type of loan is a loan that has a mortgage rate that will change throughout the lifespan of the loan. This means your monthly payment can rise or drop depending on the change in the ARM rate. A fixed rate mortgage has the same interest rate that never changes. This is nice because you will always know your monthly payments.
ARM loans have a fixed-rate period where your interest rate does not change. The fixed-rate period usually lasts from six months to 10 years. Once the fixed-rate period is over, the adjustment period hits. The adjustment period is the time when it is decided how often your interest rate can change. The adjustment rate is determined by the current market and the specific loan terms.
There are different types of ARMs and they each name something different. The name and terms are based on the duration of the initial period and how often in a year the rate can adjust during the adjustment period. For example a 5/1 ARM is the name of the ARM loan and it indicates the loan terms which are five years that the rate will not change and the rate can only change once a year 5(years)/1 (once a year).
Along with this you are offered a rate cap. A rate cap refers to how much your rate can increase or decrease. There are three different types of caps. The initial cap which is the amount your rate can adjust when it first starts to adjust. Then there is the periodic cap which is the limit of how much your rate can increase from one adjustment period to the next. The last cap is the lifetime cap, which limits how much your rate can increase or decrease over the lifetime of the loan.
Homeowners go this route when they want to take advantage of the lower rates during the initial period. If you are planning on staying in a home five years or under or before the adjustment period hits, then it is beneficial to go with an ARM loan. If rates are very high when you purchase a home, then go with an ARM instead of a fixed-mortgage. Always remember, that there is uncertainty with an ARM due to the constant change of rates. Keep in mind that you still have to make your monthly payment even if your payments have gone up a significant amount due to a rise in rates.
If you are in the market for a mortgage, shop around for a lender that works for you. If you are in the market for a new home, a Realtor can help you with the home buying process.