Adjustable-Rate Mortgages (ARMs)
Are they for me? Features, Benefits, and Risks
Adjustable-Rate Mortgages (ARMs) are home loans that have an interest
rate that changes periodically (unlike fixed-rate mortgages, which
have an interest rate that remains the same for the life of the
ARM: Benefits and Risks
Lenders generally charge lower initial interest rates for ARMs
than for fixed-rate mortgages, which makes the ARM easier on your
pocketbook at first than a fixed-rate mortgage for the same amount.
It also means that you might qualify for a larger loan because lenders
sometimes make the decision about whether to extend a loan on the
basis of your current income and the first year's payments. If interest
rates remain steady or move lower, your ARM could be less expensive
over a long period than a fixed-rate mortgage.
Weighed against these benefits, you assume the risk that interest
rates will increase and result in higher monthly payments after
your initial interest rate period has expired. It is a trade-off
– you get a lower rate with an ARM in exchange for assuming
An ARM has four key features:
- Initial interest rate period
- Interest rate cap structure
When the initial interest rate period has expired, the new interest
rate is calculated by adding a margin to the index. Your lender
will disclose the margin at time of loan application (margins may
vary from lender to lender, so it is a good idea to shop around
for a low margin). As the index figure moves up or down, your interest
rate will be adjusted accordingly.
Increases or decreases in the interest rate will be limited by
the interest rate cap structure of your loan, which provides protection
from large interest rate swings. There are two types of caps: annual,
and life-of-the-loan. The annual cap restricts the amount your interest
rate can change, up or down, in any given year, while the life-of-the-loan
cap limits the maximum (and minimum) interest rate you can pay for
as long as you have the mortgage.
ARM: Right for Me?
If an ARM is the right type of loan for you depends on your financial
situation and the terms of the ARM. ARMs carry risks in periods
of rising interest rates, but they can be cheaper over a longer
term if interest rates decline. An ARM may be a good option to consider
if you plan to own your home for only a few years, you expect an
increase in future earnings, or the prevailing interest rate for
a fixed-rate mortgage is too high.
Some questions to consider are:
- Is my income likely to rise enough to cover higher mortgage
payments if interest rates go up?
- Will I be taking on other sizable debts, such as a loan for
a car or school tuition, in the near future?
- How long do I plan to own this home? (If you plan to sell soon,
rising interest rates may not pose the problem they do if you
plan to own the house for a long time.)
- Can my payments increase even if interest rates generally do
The information provided in this website is
not legal advice and should not be interpreted as legal advice.
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information in summary form. This information may not be comprehensive,
is subject to change, and may not apply to all individual circumstances.
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