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Adjustable-Rate Mortgage

ADJUSTABLE-RATE MORTGAGE

What is an ARM?

An adjustable-rate mortgage, or ARM, has an introductory interest rate that lasts a set period of time and adjusts annually thereafter for the remaining time period. After the set time period your interest rate will change and so will your monthly payment.

Examples:

  • 10/1 ARM: Your interest rate is set for 10 years then adjusts for 20 years.
  • 7/1 ARM: Your interest rate is set for 7 years then adjusts for 23 years.
  • 5/1 ARM: Your interest rate is set for 5 years then adjusts for 25 years.

General Advantages and Disadvantages

The initial interest rates for adjustable-rate mortgages are normally lower than a fixed rate mortgage, which in turn means your monthly payment is lower. If you only plan to stay in your home for a short period of time (5-7 years), an ARM loan might be advantageous to you because you plan on moving or selling your home before your initial mortgage rate adjusts. If you expect your income to increase in the future, you might feel comfortable with the idea of saving money now by having a lower monthly payment but be comfortable with having to make higher payments in the future when your income increases, and your ARM adjusts.

ARMs are generally considered riskier because your interest rate will probably go up after the initial fixed-rate period ends.

How an Adjustable-Rate mortgage works

  • Interest rates are fixed for a period of 5, 7 or 10 years. After the fixed-rate period, your interest rate may change once per year – either up or down depending on market conditions
  • Rate changes are capped at 5% above your initial fixed rate and 2% or 5% per adjustment period, which means you’re protected. For example, if your initial interest rate is 2.99%, your rate will never be higher than 7.99%, and it will never rise more than 2% per year after the fixed-rate period
  • Your actual payment will vary based on your situation and the current interest rates when you apply
  • You can pay your mortgage at any time without prepayment penalties
  • FHA and VA ARMs are also available for those who want the flexible guidelines of an FHA or VA loan

Key Points

  • Low rate for a fixed period of time
  • Lower payment for a fixed period of time
  • Rate changes
  • Payment changes