What Is An Adjustable Rate Mortgage (ARM)?

09.15.2020 | Category: Homebuying

An important step in the home buying process is determining your personal and financial goals. When a prospective buyers knows their goals, it is easier to understand the impact interest rates and loan terms will have on their mortgage. Although the 30-year-fixed mortgage is one of the most widely recognized mortgage loans in the U.S., many homebuyers could benefit from an adjustable rate mortgage (ARM). In order to make the right decision for what type of mortgage best suits a borrower’s needs, it is important to have a good understanding of what an ARM mortgage is and how it works.

An adjustable rate mortgage (ARM) is also known as a variable-rate mortgage because the interest rate applied on the outstanding balance of the loan adjusts or varies throughout the life of the loan based on interest rates in the marketplace.

As the interest rate rises or falls, an ARM mortgage payment will increase or decrease respectively. The interest rate fluctuates over the life of the loan based on market conditions, but the loan agreement generally will set maximum and minimum rates.

What Is The Difference Between An ARM and A Fixed Rate Mortgage?

Understanding the different type of loan options a homebuyer has available will ensure they select the right type of loan for their needs. The difference between a fixed-rate mortgage and an adjustable mortgage loan is that a fixed-rate mortgage’s interest rate is set when you take out the loan. It does not change over the life span of the loan. An adjustable rate mortgage interest rate may go up or down based on the current interest rate.

What Are The Benefits Of An ARM Mortgage?

The two main benefits of an ARM mortgage are the lower interest which is initially offered to a borrower, and the flexible loan terms an ARM mortgage provides.

ARM mortgages may allow a potential homebuyer to have more budget flexibility and purchase a home at a higher market price or provide a lower down payment.

Additionally, an ARM mortgage is flexible. There are different options for the length of the introductory period as well as how many times it adjusts over the life of the loan. This flexibility is advantageous if a homebuyer does not plan to live in their home for a long time.

How Often Does An Adjustable Rate Mortgage Change?

How often an ARM mortgage adjusts or changes over the life of the loan depends on the terms that are established when the loan is set up. Typically, an ARM will offer an initial rate, or a teaser rate for the introductory period. This rate is often lower than a fixed-rate loan interest rate, and is offered during a specified period of time. During the introductory period, the loan’s interest rate remains unchanged.

The introductory period for ARM loans can range from one year to seven years. However, many ARM mortgage loans offer borrowers an introductory period of five to seven years. The length of the introductory period will vary based on other borrower requirements and eligibilities.

After the initial period ends, the interest rate for an ARM mortgage loan will adjust. With an ARM, the interest rate changes periodically, usually in relation to an index, and payments may go up or down accordingly.

The ARM mortgage rates will adjust based on a few factors that are determined when the loan is established. These are:

Adjustment Period

This is how frequently the lender can adjust the interest rate on the loan. There is a cap set in place to the amount the loan increases during this time period.