Adjustable Rate Mortgage (ARM) is a type of mortgage loan where the interest rate fluctuates over time based on changes in the market. ARMs have become very popular in recent times, especially among first-time homebuyers who want to take advantage of low initial interest rates. In this post, we will discuss everything you need to know about Adjustable Rate Mortgages.
How does an ARM work?
An ARM typically has a fixed interest rate for an initial period, usually between 5-10 years. After the initial period ends, the interest rate can change annually based on fluctuations in the market index. The new interest rate is determined by adding a margin (a set percentage) to the index value at that time.
For example, if your ARM has a margin of 2% and the index value is 4%, then your new interest rate would be 6%. However, there are caps on how much your interest rate can increase or decrease each year and over the life of your loan.
Types of ARMs
There are two main types of ARMs: Hybrid ARMs and Interest-only ARMs.
Hybrid ARMs have a fixed-interest-rate for an initial period before switching to an adjustable-rate later. For instance, a 5/1 ARM means that you’ll have five years with fixed-interest-rates before changing every year after that.
Interest-only ARMS allow borrowers only to pay interests without paying off their principal balance during their first few years; they then start repaying both principal balance & Interests once it becomes due after these initial periods expire.
Advantages
One significant benefit of Adjustable Rate Mortgages is lower monthly payments compared to Fixed-Rate Mortgages during your introductory phase because they offer lower starting rates than FRM products. If you don’t intend on living in your house for more than ten years or plan on refinancing soon after taking out this kind of mortgage product – knowing when market rates are favorable – then ARM loans may work well for you.
Disadvantages
The main disadvantage of Adjustable Rate Mortgages is that your interest rate can increase significantly after the introductory period. This means that your monthly payments could potentially become more costly than if you had taken out a Fixed-Rate Mortgage initially. Additionally, not knowing how much your monthly payments will be in the future makes budgeting difficult.
Conclusion
In conclusion, Adjustable Rate Mortgages offer lower starting interest rates and lower monthly payments compared to Fixed-Rate Mortgages. However, they come with higher risks because of potential fluctuations in interest rates over time. Therefore, it’s essential to have an understanding of the risks and benefits before deciding whether or not ARMs are right for you.