An adjustable rate mortgage, or ARM, is a type of home loan that starts with a low, fixed-rate introductory period and then adjusts upwards to a higher, variable rate. The initial interest rate on an ARM is typically lower than the interest rate on a fixed-rate mortgage, making it an attractive option for homebuyers who are looking to save money on their monthly mortgage payments.
However, there is one key downside to an ARM: the interest rate is not fixed for the life of the loan, which means that your monthly payments could go up – sometimes significantly – after the introductory period ends. For this reason, it’s important to understand how ARMs work before you decide whether this type of mortgage is right for you.
The best way to find the right information for you is to do the research, talk to professionals and weigh your options. Armed with the right information, you can make a better-informed decision that puts your needs, and budget, first. OnlineLoansFlorida.com is a experienced personal finance blog. They writing blogs and articles on money, debt and loans since 2010.
How Adjustable Rate Mortgages Work
As we mentioned, adjustable rate mortgages typically start with a low, fixed-rate introductory period. The length of this period can vary from loan to loan, but it is typically five, seven, or 10 years. After the introductory period ends, the interest rate on the loan will adjust upwards to a variable rate.
The new interest rate will be based on an index plus a margin. The index is usually the London Interbank Offered Rate (LIBOR), which is the rate that banks charge each other for short-term loans. The margin is a fixed percentage rate that is added to the index to determine the new interest rate on the loan.
For example, let’s say you have a 5/1 ARM with an interest rate of 3.5%. This means that your interest rate will be fixed for the first five years of the loan, and then it will adjust every year after that. Let’s say the index rate is 2.5% and the margin is 2.0%. This means that your new interest rate will be 4.5% (2.5% + 2.0%).
As you can see, the interest rate on your loan can go up quite a bit after the introductory period ends. This is why it’s important to understand how ARMs work before you decide to get one.
The Benefits of Adjustable Rate Mortgages
Despite the potential for rising interest rates, there are still some advantages to adjustable rate mortgages.
The most obvious benefit is the lower interest rate during the introductory period. This can save you a significant amount of money on your monthly mortgage payments. For example, let’s say you have a $250,000 mortgage with a 5% interest rate. Your monthly payment would be $1,342. If you got a 5/1 ARM with a 3.5% interest rate, your monthly payment would be $1,195 – a savings of $147 per month.
Another benefit of adjustable rate mortgages is that they can help you qualify for a bigger loan. This is because the lower interest rate during the introductory period means that your monthly payments will be lower, which means you can qualify for a bigger loan. This can be a great option for homebuyers who want to buy a more expensive home than they would be able to afford with a fixed-rate mortgage.
The Downsides of Adjustable Rate Mortgages
As we mentioned, the biggest downside of adjustable rate mortgages is the fact that the interest rate is not fixed for the life of the loan. This means that your monthly payments could go up – sometimes significantly – after the introductory period ends.
For example, let’s say you have a $250,000 mortgage with a 5/1 ARM and an interest rate of 3.5%. This means your interest rate will be fixed for the first five years and then will adjust every year after that. Let’s say the index rate is 5.0% and the margin is 2.0%. This means your new interest rate will be 7.0% (5.0% + 2.0%).
At a 7% interest rate, your monthly payment would be $1,698 – a increase of $356 per month from your payment at the 3.5% interest rate. As you can see, your monthly payments can increase quite a bit after the introductory period ends.
Another downside of adjustable rate mortgages is that they can be hard to refinance. This is because the interest rate on your loan will adjust upwards after the introductory period, which means your monthly payments will go up. This can make it hard to qualify for a new loan with a lower interest rate.
Should You Get an Adjustable Rate Mortgage?
Adjustable rate mortgages can be a great option for homebuyers who are looking to save money on their monthly mortgage payments. However, it’s important to understand how they
