Adjustable Rate Mortgages

Adjustable Rate Mortgages


Adjustable rate mortgages, or ARMs, are popular with homeowners who want the lowest possible monthly payment, but have the understanding that the interest rate and the mortgage payment can go up when the interest rate resets.

An ARM features an introductory interest rate that lasts for a specific period of time, such as one year or five years, before it resets or adjusts at set intervals for the rest of the loan term. Adjustable rate loans typically have lower rates than fixed mortgages, although it is important to remember that your payment will change when the interest rate changes. With most ARMs, the monthly payment is capped and will not exceed a certain amount for some degree of security.

Depending on the terms of the ARM you choose, you can have an initial fixed interest period of one month to ten years or more. A one-year ARM, in which the first rate adjustment occurred after one year, was the most popular ARM in past years, but today's borrowers usually prefer the 5-year and 7-year ARMs. The 5/1 ARM is one of the most widely used adjustable rate mortgages with a fixed interest rate for 5 years, which then adjusts every 12 months afterward. This type ARM is also called a hybrid mortgage, as it combines a long fixed interest rate period in the beginning with a longer adjustable period of the loan.

Adjustable Rate Mortgages

Benefits of ARMs

There are many benefits to an adjustable rate mortgage. You may consider applying for this type of loan with Summit Funding for the following reasons.

  • If you do not want to stay in your home for a long time, you can save more money with an ARM and potentially move before the loan rate even resets.
  • You can take advantage of dropping interest rates without the cost of refinancing.
  • Your monthly payments will be lower for the beginning of your loan compared to a fixed-rate mortgage.
Interest Rate

Disadvantages of ARMs


As with any loan option, it is important to consider the benefits as well as the disadvantages of ARMs before you make a decision. Adjustable rate loans are generally considered riskier than a fixed rate mortgage. This is because there is a very good chance the interest rate will climb after the introductory period. This is especially true as rates have been near historic lows for years, and they have nowhere to go but higher. What this means for you is that your monthly payments can climb significantly over a few years, potentially turning a 4% ARM into an 8% mortgage, if interest rates climb very quickly.

Keep in mind the first adjustment on an ARM is usually the worst. This is because most of the annual caps on changes to your payment will not apply to this first rate reset, but they will apply afterward.

Many borrowers also find that adjustable rate loans are more difficult to understand than the straightforward fixed-rate mortgage. An adjustable mortgage has several terms and features to choose from, and some may seem confusing. This is made more complicated by the fact that a lender can choose the margins, caps, and adjustment indexes which makes it difficult to compare loans between lenders. At Summit Funding, we strive to make the lending experience as straightforward as possible and we will help you understand the terms of your ARM.

Hybrid Mortgage

Mortgage Rates Adjustments

You can better understand how your adjustable mortgage rate will drop or rise by looking at the index or margin that it is tied to. Most ARMs are associated with common indexes such as the United States Treasury Bill (T-Bill) or London Interbank Offered Rate (LIBOR). Margins, meanwhile, are fixed rates that are added to the index rate. You can use this information to understand the fully indexed rate of your loan and even negotiate the margin rate.

If you have an index rate of 4% on your loan with a 1.5% margin rate, the fully indexed rate of your mortgage is 5.5%.

ARM Interest Rate

Mortgage Rates Caps

You are protected against significant increases in your payment with ARM cap limits. These limits are the most your rate and payment will change over the life of your loan. Here are some of the most common caps to look at:

  • Payment caps will limit the amount your payment can increase over the loan. This will be a dollar amount.
  • A periodic rate cap will limit the amount your interest rate can change during a single reset. This is usually an annual cap.
  • A lifetime cap will limit the amount your rate can increase over the entire loan term.

ARMs are not appropriate for every borrower, but there are many situations in which an adjustable loan is perfect.

ARM Adjustments

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