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Adjustable Rate Mortgage

Adjustable rate mortgages are mortgage loan programs where the interest rate may change throughout the term of the loan. Adjustable rate mortgages are very popular because they offer borrowers low interest rates. After a predetermined amount of time, the rate will change, usually bi-annually.

With an ARM, the interest rate will stay fixed for a certain period of time before the interest rate adjusts. This initial period can last for as little as one month or as long as ten years. Many borrowers choose 5-year and 7-year adjustable rate mortgages.

Adjustable Rate Mortgage Caps

You can prevent dramatic increases in your monthly mortgage payment with a cap limit. Caps can vary depending on the term of the loan. The following include a few common types of caps used in adjustable rate mortgages.

Lifetime cap. The lifetime cap limits the interest rate over the length of the mortgage.
Periodic cap. Periodic rate caps limit the amount of rate change. This typically is in the form of an annual ceiling on the annual rise of your interest rate.
Payment cap. These caps limit how much your monthly payments rise over the length of the loan. This cap is set in dollars, not a percentage.

Benefits of an Adjustable Rate Mortgage

Lower monthly payments. The monthly payments on an ARM home loan are typically
lower than on a fixed rate mortgage.
Enjoy falling interest rates. If interest rates fall, so do your payments.
Borrowers who plan on relocating enjoy lower payments. This is a great choice if you plan on moving before your loan adjusts or you have to move often for work.
Making extra payments. If you plan on paying the loan off faster with extra payments, you might as well take advantage of the ARM’s lower interest rate.

Risks of an ARM Mortgage

There are some risks involved when taking out an adjustable rate mortgage. Fixed rate loans are usually safer investments in comparison, especially when interest rates are low. The payments on an adjustable rate mortgage can change dramatically over just a few years. If rates go up fast, a 3.5% ARM could easily jump to a 6% loan in 4 years.

The first adjustment on an adjustable rate mortgage will usually be the worst, since caps on annual payments won’t apply. ARM’s can be confusing, especially since lenders can choose their own indexes, caps and margins. Despite the risks, there are several advantages to adjustable rate mortgage loans.

ARM Adjustment

The fully indexed rate is the rate by which your payment amount is determined. This number is derived from a mortgage loan’s index and margin when added together. The United States Treasury and similar bodies help form a common index. When you apply for a mortgage, you may negotiate your margin rate with the lender.