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What is an Adjustable Rate Mortgage?
With Adjustable-Rate Mortgages (ARMs) interest rates are tied directly to the economy so your monthly payment could rise or fall. Because you're essentially sharing the market risks with the lender, you are compensated with an introductory rate that is lower than the going fixed rate.
How often does the interest rate change?
That depends on the loan. Changes can occur every six months, annually, once every three years or whenever the mortgage dictates.
How much can my rate change?
Your ARM will stipulate a percentage cap for each adjustment period, which means your interest may not increase beyond that percentage point. If the market holds steady, there may be no increase at all. You may even see your payment decrease if interest rates fall.
How are the changes determined?
Every ARM loan is tied to a financial market index, such as CDs, T-Bills or LIBOR rates. Your rate is determined by adding an additional percentage (known as a margin) to that index's rate. When the index rises or falls, your rate rises or falls with it.
Is there a limit to how much interest I'll be charged?
Yes. It's called a ceiling, or lifetime cap. This is a guarantee that your interest rate will never exceed a designated percentage. For instance, if your introductory rate was 5% and you have a lifetime rate cap of 6% (meaning that your interest rate can never increase more than 6% during the life of the loan) then your ceiling would be 11%.
What are the benefits of an ARM?
- With a lower initial interest rate (usually 2% to 3% lower than fixed-rate mortgages), qualifying is easier and the payments are more manageable at first.
- You may qualify for a larger loan than you would with a fixed-rate mortgage.
- If you're only planning to stay a short time the interest rate is likely to stay lower than that of a fixed-rate mortgage.
- If you expect regular pay increases that would cover the increase in your interest, or if you believe interest rates will fall, an ARM might be the wiser choice.
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