What is an ARM?
An adjustable-rate mortgage (ARM) is a home loan with an interest rate that adjusts over time based on the market. ARMs typically start with a lower interest rate than fixed-rate mortgages. If you are rate conscious an ARM is a great option if your goal is to get the lowest possible rate.
The initial low interest rate does not last forever. After the initial period, your monthly payment can fluctuate.
ARMs are long-term home loans with two different periods, called the fixed period and the adjustable period.
Fixed Period: First, there’s an initial fixed-rate period in which your interest rate won’t change.
Adjustment period: A period when your interest rate goes up or down based on benchmark changes.
Today’s ARMs are typically hybrid ARMs, which usually have a fixed interest rate for a period of 6 months, or three, five, seven or 10 years, followed by an annually or semi-annually adjusted mortgage rate for the rest of the 30- or 15-year loan term. The amount the interest rate can adjust is capped for the first adjustment (initial cap), subsequent adjustments (periodic cap), and an overall maximum adjustment (lifetime cap).
Why should you consider an ARM?
Getting an adjustable-rate mortgage makes the most sense in situations where there’s a big gap between fixed and variable mortgage rates and an expectation that at least one of the following situations will occur during your fixed term:
- You’ll sell the property.
- Interest rates will decline, giving you the opportunity to refinance into a fixed mortgage.
- Your rate caps are manageable, and you can still afford the home during the variable period, assuming a worst-case scenario