An adjustable-rate mortgage (ARM) is a loan program made up of two parts: a fixed rate period, and a series of rate adjustment periods. After the pre-determined fixed period ends, the interest rates change as the market conditions change.
This can be considered a riskier option than the fixed-rate mortgage, because there is no guarantee that the market will shift in your favor.
Let’s Back Up.
What Does All That Mean, Exactly?
When you apply for an adjustable-rate mortgage, you have a few options to choose from. The most common are the 5/1 ARM, 7/1 ARM and 10/1 ARM: five- , seven-, and ten-year options.
The 5/1 ARM consists of a five-year fixed rate period. You will pay with one static interest rate for this entire period. After the 5 years are up, the rate will begin to adjust. The “1” in the “5/1 ARM” represents how often the rate changes after the fixed period ends: every 1 year. This pattern is the same for 3/1, 7/1, and 10/1 ARMs.
Why Are People Interested in the Adjustable Rate Mortgage?
People are typically able to benefit from an ARM if they:
- seek more financial flexibility in the beginning of the loan
- don’t plan on living in one place for a long time
- don’t want to deal with a refinance if the market improves
Though the shifting interest rates can be risky, there are plenty of benefits to the ARM:
- a lower fixed interest rate than the fixed-rate mortgage offers
- lower initial monthly payments
- limits on how much your payments can increase
- down payments exceeding 20% to negate the PMI
- ability to start with as little as 3% down
That’s a lot to consider. At the end of the day, what type of loan you seek depends on your financial situation and goals. This can be best determined by speaking with a professional.
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