An adjustable-rate mortgage, or ARM, is a home loan with an interest rate that can change periodically. This means that the monthly payments can go up or down. ARMs may start with lower monthly payments than fixed-rate mortgages, but keep in mind that your payment can go up even if interest rates don’t go up. With an ARM, the interest rate changes periodically, usually in relation to an index, and payments may go up or down accordingly.
Lenders generally charge lower initial interest rates for ARMs than for fixed-rate mortgages. At first, this makes the ARM easier on your pocketbook than would be a fixed-rate mortgage for the same loan amount. Moreover, your ARM could be less expensive over a long period than a fixed-rate mortgage—for example, if interest rates remain steady or move lower.
Types of Adjustable Rate Mortgages (ARMs)
There are a variety of adjustable rate mortgage types. Some ARMs are fixed for a portion of time while others may be configured with various payment options
Hybrid ARMs often are advertised as 3/1 or 5/1 ARMs—you might also see ads for 7/1 or 10/1 ARMs. These loans are a mix— or a hybrid—of a fixed-rate period and an adjustable-rate period. The interest rate is fixed for the first few years of these loans—for example, for 5 years in a 5/1 ARM
Interest Only ARMs
An interest-only (I-O) ARM payment plan allows you to pay only the interest for a specifi ed number of years, typically for 3 to 10 years. This allows you to have smaller monthly payments for a period. Aft er that, your monthly payment will increase—even if interest rates stay the same—because you must start paying back the principal as well as the interest each month.
A payment-option ARM is an adjustable-rate mortgage that allows you to choose among several payment options each month. The options typically include the following: traditional, interest only, and/or minimum payment
Advantages & Disadvantages of Adjustable Rate Mortgages
There are strategic advantages and some disadvantages that should be evaluated when considering an adjustable rate mortgage (ARM).
- Generally, the initial interest rate is lower than on a comparable fixed-rate mortgage.
- After the fixed-rate period ends, the interest rate can go lower, so monthly payments can fall, too
- After the fixed-rate period ends, the interest rate can rise, so monthly payments can go up, too.
- Interest rates are unpredictable, so you cannot predict what your payments will be in the future.