- Adjustable Rate Mortgages (ARM’s) are less common than fixed rate mortgages.
- ARM interest rates are lower than comparable fixed rates.
- ARM’s have an interest rate that adjusts on a pre-determined basis, depending on a market index.
- ARM’s have rate adjustment caps that limit the extent to which the interest rate can rise.
- ARM’s are fully amortizing, which means that you will pay down the principal balance completely by the end of the loan term.
- ARM’s are available in a wide variety of terms that include a variety of fixed interest rate periods with different frequencies for interest rate adjustments.
- For example, if you have a 5/1 ARM, the interest rate is fixed for the first five years and then the rate adjusts once each year beginning in year 6.
- There are a few ARM terms that are important to understanding how the ARM will function.
- Index: The Index is the economic indicator that is used as the proxy for calculating the interest-rate adjustments for ARMs. Some commonly used Indices include the 10 year treasury yield and LIBOR rates.
- Initial Cap: The Initial Cap is the maximum amount the interest rate can adjust after the fixed-period.
- Periodic Cap: The periodic cap limits the interest-rate increase from one adjustment period to the next.
- Lifetime Cap: The lifetime cap puts a limit on the interest-rate increase over the life of the loan. All adjustable-rate mortgages have an overall cap.
- You can pay down your mortgage or refinance your ARM at any time without any penalties.
- ARM’s enable you to obtain the lowest interest rate possible, which may enable you to buy a more expensive home.
- If you do not plan on living in your home for a long period of time, an ARM can reduce your overall payments and create significant savings in the time that you do live in your home.
- If you expect interest rates to decline, you may benefit from an ARM. Although interest rates can rise, they can also decrease, making your payments smaller.
- Most people who have ARM’s refinance their loans prior to the fixed-rate period expiring so that they can have control over the interest rate they will be paying.