Adjustable Rate Mortgage

An adjustable rate mortgage, commonly referred to as an ARM, is a mortgage that charges a rate of interest that will change over time – or adjust – to keep pace with prevailing rates. If interest rates rise, the amount of interest you pay on an ARM will usually go up. And if rates drop, your monthly payments and rate of interest will likewise go lower.

One advantage often cited by fans of adjustable rate mortgages is that over time, the upward and downward cycles of the economy – and corresponding interest rates – will most likely average themselves out. The idea is that those with adjustable rate mortgages will be able to take full advantage of low rates to help offset the periods of higher rates.

But in practice, most people who use an ARM do so to capture lower rates for a rather short period of time, and then they either sell their property or refinance to another type of loan. They never actually keep the ARM long enough to ride the up and down roller coaster of rising and falling interest rates.

The reason for that strategy is that adjustable rate mortgages have a particular characteristic that makes them attractive to those who plan to sell or refinance after just a few years. The initial rate on an ARM is lower than typical fixed rate loan rates. And this low rate often lasts for a period of six months to 5 years, depending on the loan, so that during the months and years right after taking out an ARM, homeowners are able to pay less than they would with a conventional fixed rate mortgage.

In other words, you can buy a house with an ARM and sell it before the rate adjusts, and get a sweet deal, saving as much as 1.5 percent over a conventional fixed rate loan. Even if the ARM is set to rise when the adjustment kicks in, it won’t matter to you, because before that happens you have already sold your house, paid off the ARM mortgage, and moved on to greener pastures.

After that initial discounted rate phase expires, the ARM adjusts, and can move upward quickly. There is a cap or ceiling to regulate how high the interest rate can rise, but in most states in the USA the cap is around 9.5 percent. So one of the risks to watch out for with an ARM is that if prevailing interest rates skyrocket, your mortgage payment can also jump. 

Because an ARM carries a very competitive rate in the beginning it is a great choice for those who don’t plan to hold on to the mortgage for very long. And for those who are lucky enough or clever enough to time the direction of rates, it can also be valuable. If you predict that interest rates are going to start falling in a year or two, you can take out an adjustable rate mortgage at the special low rate, and save money immediately. Then, when your mortgage’s adjustment period arrives, the ARM will follow interest rates. If you guessed correctly and they start to sink, the cost of your mortgage payments will also go lower.

If you think an adjustable rate mortgage might work for you, just talk to one of our senior mortgage advisor at Optionwide Home Loans, and ask us to fill you in on all the details. We will help you do the math to figure out where a adjustable rate mortgage would leave you, once it is accomplish.