Adjustable Rate Mortgage (ARM) v. Fixed Mortgage

Let’s take a look at what an ARM, Adjustable Rate Mortgage, is and how it compares to a fixed rate mortgage (which sadly doesn’t have a cool acronym).

Adjustable Rate Mortgage, ARM

A type of mortgage that has an interest rate that adjusts periodically based on a pre-selected, benchmark interest rate index. With an ARM the initial interest rate is set for a fixed period. After this initial time frame, it will reset periodically depending on the agreed upon interval.

How does it differ from a fixed rate mortgage?

As mentioned previously, the interest rate can change with an adjustable rate mortgage, unlike a fixed rate mortgage, which maintains the same interest rate throughout the life of the loan. With an adjustable rate mortgage, the payments could increase or decrease with interest rate changes. This is based on the terms of your loan as well as the benchmark interest rate index, which is chosen by your lender. Due to the possible interest rate increase and thereby payment increase, an ARM could be considered riskier than a fixed rate mortgage.

When does it make sense to get an adjustable rate mortgage (ARM)?

This type of mortgage can be a good option for home buyers who plan to only have the mortgage for a few years. Perhaps someone who plans to move within the initial fixed-rate period or pay off the loan in a few years.

Some words of caution regarding adjustable rate mortgages.

  • These loans can be complicated—they have rules, fees, and structures. The complexities involved can become hazardous to borrowers who are not quite sure of what they are getting into.
  • Sometimes things do not go as planned. Even with careful planning, a borrower could be unable to sell or refinance when they had planned to, leaving them with a higher than expected payment. If they are unable to make the payments, they risk losing their home.
  • Some mortgages come with a pre-payment penalty, so should the borrower refinance or sell their home they could be charged with a fee. If you plan to sell or refinance before the loan term ends, be sure to ask your lender about any pre-payment charges.

Just as with any mortgage type, do not be afraid to ask questions. This is especially true with an adjustable rate mortgage. Be sure to ask your mortgage banker to explain the risks and exactly how much the payments could increase.

 

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