Mortgage lenders toss all kinds of lingo at you — APR, fixed rate, equity, points, and, yes, ARMs. Sadly “points” doesn’t refer to anything as exciting as those scored during March Madness last month, and ARMs have nothing to do with appendages. ARM stands for “adjustable rate mortgage.” That may not tell you much more, so let’s define them further.
What Is an Adjustable Rate Mortgage?
Adjustable rate mortgages are mortgages where the interest rate applied to your outstanding balance fluctuates throughout the life of your loan. In most cases, the initial interest rate is fixed for a set period of time. ARMs typically start out at a rate lower than that of a traditional 30-year fixed rate mortgage. Once the initial period is over, the rate fluctuates based on the market conditions. Loan agreements should have a lifetime cap, keeping the monthly payments below a set threshold.
You may be wondering how this affects your payments. As the interest rates increase, your payments do, too. But if they go down, your payments also go down. One thing to keep in mind is when rates change, they are applied to the remaining balance on your loan, not on the full initial loan amount. This factor can help minimize the amount of payment change.
What Do the Numbers Mean?
Each adjustable rate mortgage fluctuates on a predetermined schedule. You’ll know this schedule based on the name of the loan. A 1-year ARM adjusts every year. A 3-year ARM’s rates change every three years. You’ll also see hybrid loans advertised that look like this: 5/1 ARM. If you’re considering a 5/1 loan, you would have an initial set period of five years, then the interest rate would adjust every year starting in year six. The first number expresses how long the initial period runs, while the second number tells you how frequently the rates will change after the initial period is up.
Is an ARM Right for You?
Many people fear this kind of mortgage, because payments can fluctuate so greatly. If your budget can handle the fluidity of frequent payment changes, you can save substantial amounts of money by opting for an ARM. This is because initial period rates are typically much lower. Also, if you are not planning on staying in your home for the long term, perhaps you will only be there for four years and the initial period lasts for five, then this could be a great option for you. Be sure to still pay close attention to rate caps, though, in case you end up staying longer than planned.
Where Can I Learn More?
The Consumer Financial Protection Bureau created a thorough, informative handbook on ARMs. Take a look; I don’t think they left a single detail out! And feel free to call me or your mortgage lender to explore all your real estate options!
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