Adjustable Rate Mortgage FAQ

Adjustable rate mortgage loans are an option for some homebuyers. Depending on your particular financial situation and other factors, this could prove to be a good move. If you are considering an adjustable rate mortgage, here is what you need to know. 

What Is an Adjustable Rate Mortgage?

An adjustable rate mortgage, or ARM, is a loan in which the first years of the loan have a fixed interest rate. The amount of time can vary by lender. After the period passes, the interest rate can be changed each year until the loan is paid off. A five-year ARM is the most common type offered by lenders.

The fluctuations to the interest rate following the fixed rate period can impact how much you pay monthly for your home. For instance, if the interest rate is low, your monthly payments could potentially decrease. 

What Are the Pros and Cons of an ARM?

One of the main benefits of taking an ARM is you can save money in the fixed rate period. If the fixed rate interest rate is particularly low, your payments can make a significant dent in what you owe in principal. Instead of paying high rates of interest, you would be contributing more to the principal. 

However, there is a drawback to the ARM. Once the fixed rate period ends, you could end up paying far more than expected. The interest rate that you are offered depends largely on the rates set by the Federal Reserve. As a result, you could pay more and more each year to stay in your home. 

Can You Protect Yourself?

If you are considering an ARM, there is a way to protect yourself and still reap the benefits of the loan. You need to ensure that your loan agreement includes a cap on the amount of increase to the interest rate. 

The cap needs to not only apply to how high it can go, but also to when it can be applied. You can even ask for a cap on the amount that you pay monthly on your home. If you are granted a cap, you need to determine whether it is for the lifespan of the loan or is it just a temporary cap.

Ideally, you are working with a real estate agent and attorney. They can help you determine whether or not the terms you are being offered by the lender are fair to you and offer insight on what is reasonable.