What is an ARM?
An Adjustable-Rate Mortgage (also called a variable-rate or floating mortgage) is a type of mortgage where the interest rate applied on the outstanding balance varies throughout the life of the loan. The initial interest rate is fixed for a period of time, then resets periodically at yearly, or sometimes monthly, intervals. The interest rate is reset based on a benchmark, or index, as well as a spread called an ARM margin.
ARM interest rates increase or decrease based on an index plus a set margin. While the index rate can change, the margin always stays the same. So, if the index is 6% and the margin is 2%, the interest rate on the mortgage adjusts to 8%. Given this same formula, if the index is only at 3% the next time the interest rate adjusts, the rate will fall to 5%, based on the same 2% margin.
An ARM is presented as two numbers. For example, a 5/1 ARM features a fixed rate for five years and a variable rate that adjusts every year (hence the number one). The first number indicates the length of time the fixed rate is applied to the loan, and the second number indicates the amount of time before variable interest readjusts thereafter.
Why Choose an ARM?
An ARM can be a smart financial decision if the home buyer is planning on paying off the loan in full sooner, or if they will not be hurt by an increase in interest rate adjustment. Notably, ARMs come with rate caps that limit how high the rate can increase each adjustment period, or how drastically the payments can change. In that sense, there is some peace of mind attached to these loans.
The biggest advantage of an ARM is that it is considerably cheaper than a fixed-rate mortgage, at least for the first three, five, or seven years. They are also attractive because their low initial payments often enable the borrower to qualify for a larger loan. In addition, if interest rates fall during the life of their loan, the borrower can enjoy lower payments without the need to refinance the mortgage.
What to Consider
When choosing a mortgage loan, the borrower should consider a wide range of personal factors, do their research, and answer a few questions honestly:
- How large a mortgage payment can I afford today?
- Could I still afford an ARM if interest rates rise?
- How long do I intend to live on the property?
- In what direction are interest rates heading, and will that trend continue?
If you are interested in learning more about ARMs and what option is best for you, please contact one of our loan officers at (760) 930-0569 and we will be happy to assist you.