Agent Offfers
Realty Times TV

What is an Adjustable Rate Mortgage?

Written by Posted On Monday, 09 March 2020 16:10

What is an Adjustable Rate Mortgage?

An adjustable rate mortgage, also known as an ARM, is an alternative type of loan compared to your typical conventional mortgage. A fixed or conventional mortgage is simple to understand. Your monthly payment is configured off of an interest rate that will never change over the life of the loan.  There are no surprises and the homeowner makes the same monthly payment. It certainly will give the buyer peace of mind.

However, an ARM will require more attention and care. An adjustable rate mortgage is not a scam, nor is it a poor decision. It does require understanding. We will cover exactly what an ARM is, some real life examples, and who might best want to engage in this alternative.

An ARM Defined

An ARM does initially operate in a similar manner to a fixed rate mortgage, but then diverges. Simply put, the interest rate on your mortgage payment can go up or down during certain periods in the loan. Yes, your mortgage payment could potentially go down presented with the right interest rate climate. 

If the interest rate on your mortgage goes up, then your monthly payment will go up. There are inherent dangers for those on a fixed income. And this type of mortgage operates by its own set of rules. 

Let's be clear. The only reason you might ever want to engage in this type of mortgage is for the lower monthly payment. 

Teaser Rate

Each ARM will have an initial teaser rate. This teaser rate is always lower than its conventional brethren. During this period, the ARM will operate precisely like a fixed mortgage. The interest rate will not change. This introductory period might be as little as 1 year, or could be 5 years, or even longer. 

Adjustment Period

Now after the introductory period has expired, the interest rate on the loan is free to adjust. This is called the adjustment period. Usually these adjustment periods occur once a year, but could occur every 3 or 5 years. 

The new rate could go down, remain the same, or go up.  This will be determined by the benchmark index rate that your loan is tied to. This will dictate your new mortgage payment.  Rest assured there are caps built-in to protect your interest rate from going up too much too fast. This will limit how much the rate can change each adjustment period, and over the total life of the loan. These rules apply regardless as to whether are purchasing a home or if you are looking for a mortgage refinance.

 

It's not in the interest of the banks to force you into default. Although, they aren't doing this for free either. That's why it's always important to review your mortgage documents and ask these lender questions. 

Types of Adjustable Rate Mortgages

Let's cover a few examples and see how they work to get a better understanding. 

3/1 ARM

The first number defines how long the initial teaser period lasts. The 3 stands for years. So if you were in a 3/1 ARM, your mortgage payment would have a teaser rate for the first three years. Your payments would be the same for 36 months.  Starting the 4th year, the rate would be able to adjust based upon the market conditions. Remember your loan is tied to a specific benchmark index.

The bank will tell you what index benchmark they will use. The 1 represents how often in years the rate will reset. So starting the 4th year, and every year thereafter, your mortgage payment could be higher or lower or remain the same. 

3/3 ARM

Just like the example above, the teaser period lasts for 3 years. Now the rate is only able to adjust every 3 years thereafter. This means on year 4, 7, 10, and so on. If rates were to spike in the middle of year 7, your rate would not be able to increase until the beginning of year 10.

Here is a great ARM mortgage calculator that will show you just how this financial tool operates.  

Who an ARM is For:

Before we talk about who should engage in an adjustable rate mortgage. Here is a list of people who should avoid one.

  • Buyers on a fixed income
  • Buyers who plan on staying in their home for a very long time
  • Buyers who are adverse to any risk

Here is who might want to agree to an ARM

  • Someone who wants the lower mortgage payment
  • A buyer who knows they will be selling after a few years 
  • A buyer who believes mortgage rates will be going down
  • Buyers who can absorb the higher mortgage payments

ARM's sure have a place in the marketplace. Potential borrowers should speak with a lender and find out if an ARM is right for their scenario and to get a rate quote.

 

Author: Eric Jeanette from Dream Home Financing is an 18 year veteran in the lending industry. About Dream Home Financing

Rate this item
(0 votes)
Eric

Dream Home Financing is like a boutique lending tree. We have been matching borrowers to lenders for 15 years. We can help with all of the basic programs such as FHA, VA, USDA, conventional and more. However, our specialty is all of the niche programs. Stated income loans, bank statement loans, programs for recently divorced individuals, and more...

https://dreamhomefinancing.com

Latest from Eric

More in this category: > Ways to Make Your Home Flu-Proof 5 Reasons Why You Should Take Care of Your Carpet Regularly
back to top

Agent Resource

Before You List

Today's Headlines

Realty Times

From buying and selling advice for consumers to money-making tips for Agents, our content, updated daily, has made Realty Times® a must-read, and see, for anyone involved in Real Estate.

Links

Sections

Search

Joomla! Debug Console

Session

Profile Information

Memory Usage

Database Queries