Adjustable rate mortgages differ from fixed rate mortgages because the interest rate on the loan amount can change periodically over the life of the home loan. They are referred to as an ARM and they are popular because the initial interest amount is low. Getting an ARM on a home purchase might be a good idea for some people, especially if they plan on selling the home within a few years or if the current interest rates on a fixed rate mortgage loan are high. The thing to realize is that, depending on the time frame of the loan, your mortgage amount will change, and most likely will get higher. You can always advise with your selected real estate agent with this to get the better picture of whole process.
Each adjustable rate mortgage has a specific adjustment period. The initial period is the time frame when the initial interest rate doesn’t change. These vary from one ARM to another. It can be as short a period as six months or as long a period as ten years. It depends on the lender and the contract. You can see ARMS adjustment time frames listed as numbers like 1-1, 3-1 or 5-1, for instance. The first number is the number of years before a rate adjustment can occur. The 3-1 means that for the first three years, the mortgage rate will not change, but on the fourth year it will be adjusted.
The interest on an ARM is adjusted periodically based on two things: the index and the margin. The index is based on the financial market conditions when the adjustment time has been reached. It is a sort of guide for lenders and general contractors to calculate what interest should be charged. The margin is the percentage that can be added to the index to change the mortgage rate you will pay.
ARMs have what are called caps on the amount of interest you can be charged at the time of the rate change. This dictates how much your interest can increase or decrease over the life of the loan.
What are pros and cons or ARM?
There are, of course, pros and cons as to whether or not an ARM is a good thing for you. If the interest rates on fixed mortgages are high at the time of your home purchase, you can certainly save money initially by getting an ARM. If you do not intend to stay in the home forever, you can always sell before the first raise in the interest rate on the loan. If you know that in a certain amount of years your income will be higher than it is at the time of the purchase, you will be better able to afford an increase in your mortgage rate.
You need to shop around for an ARM that has the right details for your situation. How many years will it be before your rate changes? What are the index and the margin that will be used on your loan? What is the cap? Different mortgage lenders have different loan details. Pay attention to the details and you may benefit from an ARM as opposed to a fixed rate mortgage.