Adjustable Rate Mortgage

Adjustable-rate mortgages (ARMs) are also known as variable-rate mortgages. The interest rate changes periodically depending on the corresponding financial index that's associated with the loan. The monthly payment will increase or decrease if the index rate goes up or down throughout the life of the loan. Generally, the initial interest rate is lower than that of a comparable fixed-rate mortgage.

Most buyers who choose an ARM does so with a plan to refinance in the future. They might also choose an ARM loan because they don’t plan on living in their home for very long time or or they know they’ll earn significantly more money in coming years.

So how does this “fixed rate” time period work before the interest rate is adjusted? Typically, the interest rate changes every six to twelve months, but it can change as often as every month! Often, a loan will have a larger chunk of time where it’s fixed initially. So, five years of fixed and then a rate that changes yearly would be signified as 5/1. A fixed loan for three years and then changing every year would be a 3/1 etc. The most common ARM loan time periods are 1/1, 3/1, 5/1, 5/5 (adjusting every five years), 7/1 and 10/1.

Adjustable Rate Mortgages:

Pros of an ARM:

• Low introductory rates
• Flexibility

Cons of an ARM:

• Complexity of the loans
• Potential for much bigger payments