Adjustable Rate Mortgages (ARM)
Features and Advantages of ARMs
As the name suggests, Adjustable Rate Mortgages (ARMs) offer a fluctuating repayment plan. There are different types of ARMs and each mortgage has different features and advantages.
One feature of ARMs is that they are linked to a common index. By being linked to a common index such as London InterBank Offered Rate (LIBOR) adjustable rate mortgages can fluctuate depending on the direction of the index. So if the index increases, your interest rate and monthly payment will also increase and the same goes for the index decreasing.
An attractive feature for many borrowers is the initial rate offered by adjustable rate mortgages. The initial rate is a lower introductory interest rate that can last for up to five years on some mortgages. Although these lower monthly payments are attractive when deciding on a mortgage, homebuyers need to look past the initial rate to see if they will be able to afford the higher payments after the initial rate period has ended.
Adjustable rate mortgages (ARMs) aren’t all surprises though. Each ARM comes with an adjustment period (one year, two years, etc.) that lets you know when you can expect your monthly payment amount to change. So if you have a one year ARM that means that your payment amount will be consistent for a year and then can fluctuate. Another way to increase the predictability of your payments is through the caps on your mortgage. Caps put limits on how much your payment can fluctuate over the life of the loan, from payment to payment, and during an adjustment period.
There are different types of ARMs: hybrid, interest-only, and payment-option. Hybrid ARMs offer a fixed interest rate for the first few years. A common type of hybrid is the 5/1 ARM which offers five years of a fixed interest rate and then adjusts every year until the loan is paid in full. Interest-only ARMs let borrowers make interest-only payments for a period of time and then monthly payments will increase to start paying off the principal. A payment-option ARM gives the borrower more options to pay off the mortgage: interest-only, interest and principal, or a minimum payment.
Advantages of ARMs include lower interest rates than fixed rate mortgages and more flexibility in payments. However this flexibility means that the borrower assumes some risk since their future payments could increase substantially over the life of the loan. If you are considering an Adjustable Rate Mortgage, talker to your lender about all the different features of the loan, as well as your long term financial goals since you will be assuming a greater risk than with a fixed rate mortgage.
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