What You Need to Know About an ARM Loan
- Rebecca Singer
- Home Loans
If you are currently exploring your mortgage options, an ARM may be a great option to suit your needs, depending on your particular situation and financial goals. An ARM or Adjustable Rate Mortgage typically offers a greater flexibility in interest rates beginning with a lower initial rate and payment in comparison to a more traditional 15 year or 30 year Fixed Rate Mortgage.
Rates and Payments
One of the main features of an ARM is rate adjustability depending on market conditions. The introductory rate and payment will remain the same for a limited period of time which can range from 1 month to more than 5 years (known as a periodic adjustment cap), and after this, the rate can adjust based on the current market rates. The loan will also have a maximum rate (known as a lifetime cap) to insure that even if current market rates go too high, you won’t be required to pay more than the lifetime cap rate. Decreases in your interest rate are also possible depending on where rates move in the interest rate market.
Based on your current loan balance and the remaining life of the loan, the monthly payment will be recalculated and generally this adjustment could occur as often as every month or once every few years, depending on the loan terms. For example, a 5/1 ARM will adjust for the first time 5 years into the loan and then every year thereafter. A 7/1 ARM will adjust for the first time 7 years into the loan and then every year thereafter. An ARM could potentially be less expensive over the life of the loan if interest rates remain low or decrease. However, the tradeoff is you run the risk of rates increasing over time causing increases in your required monthly payment each time the interest rate adjusts on your loan.
Questions to Consider
According to the Consumer Handbook on Adjustable Rate Mortgages here is a list of questions to consider before selecting an ARM:
- Is my income enough—or likely to rise enough—to cover higher mortgage payments if interest rates go up?
- Will I be taking on other sizable debts, such as a loan for a car or school tuition, in the near future?
- How long do I plan to own this home? (If you plan to sell soon, rising interest rates may not pose the same problem they do if you plan to own the house for a long time.)
- Do I plan to make any additional payments or pay the loan off early?
Is an ARM Right for You?
An Adjustable Rate Mortgage could be beneficial for individuals in these types of scenarios:
- I am planning to relocate every few years for work and will sell my real property when I relocate to a new area.
- I am interested in a lower payment right now but I know I will make more money in the near future with my next promotion and I am confident that this increase in salary will protect me from increases in my mortgage payment that may occur in the future when my loan adjusts.
- I am a real estate investor who needs an investment property loan to purchase my next property, relocate the renters and then sell the property in a few years.
An adjustable rate mortgage poses various benefits as well as risks, but if you feel benefits out weigh the risks in your current situations, an ARM could be a great option. Be sure to consider all options related to your particular financial situation before selecting your mortgage product so that make the most informed and beneficial choice.