ARMs Explained
What’s an ARM? This is one of the first questions anyone new to the mortgage area asks. ARM stands for Adjustable-Rate Mortgage. An ARM is one of the other main types of mortgage besides the fixed-rate mortgage. (You will occasionally hear a fixed-rate mortgage referred to as a FRM.)
How do ARMs work? ARMs take advantage of the fact that interest rates are variable – they change daily. The majority of adjustable-rate mortgages don’t change daily, but they may change monthly, semi-annually or annually. Every time the loan’s interest rate adjusts, so does the mortgage payment.
What’s the benefit to the borrower? With a fixed-rate mortgage, the lender risks the fact that interest rates may go up over the life of the loan, which costs the lender revenue in the form of higher mortgage payments. With an ARM, the borrower is assuming the risk that interest rates will change. In exchange for the borrower accepting more of the risk, ARMs generally carry a lower initial interest rate.
What’s the potential downside to the borrower? The risk is that rates – and therefore your monthly payment - could go up. Most ARMs come with terms that cap the amount that your interest rate could rise in any one adjustment, as well as a maximum amount it can rise over the life of the loan. This is known as the lifetime cap.
Hybrid ARMs. Most borrowers aren’t willing to accept the unpredictability of a mortgage whose payment adjusts every month. However, given that the length of the average mortgage is only about seven years, lenders offer an adjustable-rate mortgage with an initial fixed term, usually lasting anywhere from one to ten years. These ARMs offer the security of a fixed payment with the rate discount of an adjustable-rate mortgage. For example, with a 5/1 ARM your rate will remain the same for the first five years and then will adjust every year afterwards. Each time your rate adjusts, your monthly payment will rise or fall based on the index and margin.
Get Started Now!
- Check Your Credit Report & Credit Score now!
- Start a Loan Request
- Sign up for our News Feeds
- Have Questions? Call 1-800-GET-SMART (1-800-438-7627)
