Adjustable Rate Mortgages

Adjustable-rate mortgages (ARMs) are also known as variable-rate mortgages. The interest rate changes periodically depending on the corresponding financial index that’s associated with the loan. The monthly payment will increase or decrease if the index rate goes up or down throughout the life of the loan. Generally, the initial interest rate is lower than that of a comparable fixed-rate mortgage.

Most buyers who choose an ARM does so with a plan to refinance in the future. They might also choose an ARM loan because they don’t plan on living in their home for very long time or or they know they’ll earn significantly more money in coming years.

So how does this “fixed rate” time period work before the interest rate is adjusted? Typically, the interest rate changes every six to twelve months, but it can change as often as every month! Often, a loan will have a larger chunk of time where it’s fixed initially. So, five years of fixed and then a rate that changes yearly would be signified as 5/1. A fixed loan for three years and then changing every year would be a 3/1 etc. The most common ARM loan time periods are 1/1, 3/1, 5/1, 5/5 (adjusting every five years), 7/1 and 10/1.

Pros of Adjustable-Rate Mortgages (ARMs):

Lower Initial Interest Rates – ARMs typically offer lower introductory rates than fixed-rate mortgages, making them more affordable in the short term.
Lower Monthly Payments (Initially) – With a lower starting interest rate, monthly payments can be lower compared to a fixed-rate mortgage.
Good for Short-Term Homeowners – If you plan to sell or refinance before the rate adjusts, you can benefit from the lower initial costs.
Potential for Lower Long-Term Costs – If interest rates stay low or decrease over time, your mortgage rate and payments could remain manageable or even decrease.
May Qualify for a Larger Loan – Lower initial payments may allow borrowers to qualify for a higher loan amount than they would with a fixed-rate mortgage.

Cons of Adjustable-Rate Mortgages (ARMs):

Rate Increases Over Time – Once the introductory period ends, interest rates can adjust periodically, potentially increasing your monthly payments.
Uncertainty in Payments – Monthly payments can fluctuate based on market interest rates, making budgeting more challenging.
Potential for Higher Long-Term Costs – If interest rates rise significantly, you could end up paying more over the life of the loan than you would with a fixed-rate mortgage.
Complex Loan Terms – ARMs have different adjustment periods, rate caps, and index factors, making them harder to understand compared to fixed-rate loans.
Risk of Payment Shock – If rates increase dramatically, monthly payments could become unaffordable, leading to financial strain or even foreclosure.