Adjustable-Rate Mortgages
Adjustable Rate Mortgages -- ARMs, as we called them above -- come in many varieties. Generally, ARMs determine what you must pay based on an outside index, perhaps the 6-month Certificate of Deposit (CD) rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others. They may adjust every six months or once a year.

Most programs have a "cap" that protects you from your monthly payment going up too much at once. There may be a cap on how much your interest rate can go up in one period -- say, no more than two percent per year, even if the underlying index goes up by more than two percent. You may have a "payment cap," that instead of capping the interest rate directly caps the amount your monthly payment can go up in one period. In addition, almost all ARM programs have a "lifetime cap" -- your interest rate can never exceed that cap amount, no matter what.

ARMs often have their lowest, most attractive rates at the beginning of the loan, and can guarantee that rate for anywhere from a month to ten years. You may hear people talking about or you may read about loans that are called "3/1 ARMs" or "5/1 ARMs" or the like. That means that the introductory rate is set for three or five years, and then adjusts according to an index every year thereafter for the life of the loan. Loans like this are often best for people who anticipate moving -- and therefore selling the house to be mortgaged -- within three or five years, depending on how long the lower rate will be in effect.

You might choose an ARM to take advantage of a lower introductory rate and count on either moving, refinancing again or simply absorbing the higher rate after the introductory rate goes up. With ARMs, you do risk your rate going up, but you also take advantage when rates go down by pocketing more money each month that would otherwise have gone toward your mortgage payment.



Interest Rates Vary. Adjustable-rate mortgages are home loans with interest rates that vary based on changes in market interest rates.


30-Year Terms. Adjustable-rate mortgages typically are 30-year terms.

Low Initial Rate. That initial rate remains constant during an introductory period. As a general rule, the shorter the introductory period, the lower the initial interest rate. Often the fixed introductory period is set based on the length of time the borrower expects to own the home.

Rate Adjustments. After the introductory period expires, the interest rate is subject to adjustment at predetermined intervals—usually every six months. Rate adjustments are based on market interest rates, but adjustment caps limit how much an interest rate can change in a specified time period.

Often, adjustable-rate mortgages offer borrowers the option of an interest-only loan for a fixed period of time. This results in a lower payment for that period. Check out our interest-only calculator for an example introductory payment.


Adjustable rate mortgages may be a good choice if you don’t plan to own the home for a long period of time, or if interest rates are high and expected to come down.

Compare a Fixed-Rate with an Adjustable-Rate Mortgage, using our calculator.

We can tell you more about adjustable-rate mortgages. 


 

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