What Is an Adjustable-Rate Mortgage (ARM)?
After your down payment
, your mortgage will finance the remainder of your home purchase. Whereas fixed-rate mortgages allow you to lock in a specific interest rate and payment for the life of your loan, adjustable-rate mortgages’ interest rates will fluctuate over time, thus changing your loan payment. It’s typical for ARMs to begin with a low introductory interest rate, but once that first stage of the loan has passed, they will begin to shift up and down. ARMs generally have a cap that specifies the maximum rate that can occur for that loan.
Let’s say you secure an adjustable-rate mortgage
with 30-year terms, the first five of which are at a fixed rate. When the variable interest portion of the loan kicks in, your mortgage’s fluctuations will be measured against an index. If the index is higher than when you secured the loan, your rate and loan payment will go up—and vice versa. How often your ARM rates change depends on your agreement with your lender. Talk to your mortgage broker
to learn more about the characteristics of adjustable-rate mortgages.
Different Types of Adjustable-Rate Mortgages (ARMs)
Payment-Option ARM: You’ll have flexibility to choose your monthly payments with a payment-option ARM, including interest-only payments and minimum payments that don’t cover interest. These loan products can get home buyers into hot water quickly when rates increase.
Interest-Only ARM: With an interest-only ARM, you pay just the interest on the loan for a specified introductory period, then the principal payments kick in on top. The longer the introductory period, the higher your payments will be when the delayed principal payments enter the equation.
Hybrid ARM: As outlined above, a hybrid ARM begins with a fixed-rate introductory period followed by an adjustable-rate period. Typically, a hybrid ARM’s fixed-rate period lasts anywhere between three to 10 years, and its rates adjust at an agreed-upon frequency during the adjustable-rate period, such as once every six months or once a year.
Pros and Cons of an Adjustable-Rate Mortgage (ARM)
- The low introductory rate allows you to save money and plan for when the adjustable-rate period kicks in.
- If you plan on selling in a few years, you can use the proceeds to pay back your mortgage before the fixed-rate period ends.
- If the index decreases over time, you could end up with a lower interest rate and monthly payments.
- If you plan to live in the home for a long time, a fixed-rate mortgage may be a better option.
- Without knowing what will happen to interest rates, your monthly payments could become unaffordable.
- Financial planning is more difficult with an ARM, since there’s no telling what your monthly payments will be one year to the next.
Home Monthly Payment Calculator
To get an idea of how your mortgage payment will fit into your budget, use our free Home Monthly Payment Calculator by clicking the button below. With current rates based on national averages and customizable mortgage terms, you can experiment with different values to get an estimate of your monthly payment for any listing price.