What is an Adjustable Rate Mortgage (ARM)?
An adjustable rate mortgage is a mortgage loan with an interest rate that changes periodically over the life of the loan. Usually, a fixed interest rate is set on the loan for a limited period of time, after which the interest rate can adjust yearly or monthly depending on the chosen index.
Among the most common indices, are the 1-year Constant Maturity Treasury (CMT) and the London Interbank Offered Rate (LIBOR).
ARM loans are often seen with two numbers, for example, a 5/1 ARM. The first number often refers to the length of time the interest rate is fixed, and the second number identifies how often the interest rate will adjust, post the initial fixed period.
For example, a 5/1 ARM refers to a 5 year fixed interest rate with the number “1” referring to the interest rate adjusting annually after the 5-year fixed term.
To determine if an Adjustable Rate Mortgage is right for you, consider the pros and cons:
- Lower interest rate and monthly mortgage payments at inception.
- A good choice for people who will own their home short-term
- A good choice for clients with a high tolerance for risk and who believe rates will be lower in the future
- May provide the temporary help needed to afford a more expensive home
- Interest rate can increase over time
- Not a good choice when expected home ownership is long-term
- Not a good choice for clients with a low tolerance for risk
- Not a good choice if the client believes interest rates will be significantly higher after the fixed interest rate period ends.