During the home buying process, many mortgage related terms are tossed around. One of these terms that is often talked about is an “ARM”. An ARM, for those who don’t know what it stands for, means Adjustable Rate Mortgage. Arms are one of many different mortgage loan options available to borrowers, and are a great option depending on your situation and future housing plans.
How Does an ARM Loan Work?
When you look at an ARM on paper, you’ll see that there are numbers in front of it, such as 10/1, 7/1, 5/1, 3/1, and you might be unsure exactly what these numbers stand for. The numbers mean that you will have a set interest rate for however long, and then after that time, it will adjust for the remainder of the 30 years. To make it easier to understand, a 10/1 ARM will have a set interest rate for 10 years, and when that time is up, there will be 20 years where the rate adjusts. Your loan payment will be the same amount for those first however many years, then will change based on the adjusted rate.
Advantages to ARMs
One of the biggest reasons that ARMs are a great option is because they have a lower fixed rate than those of traditional loans in the first few years of the loan. Whether it’s a 3/1 or 10/1 ARM, your monthly payments will be lower for whatever length of time you choose. ARMs are a great idea if you do not plan on staying in your home past the point of where the mortgage adjusts. One more advantage to an ARM is that you can save a good amount of money in the beginning of the loan to help you prepare for the possible increase that may come later on.
Disadvantages to ARMs
One of the downsides of an ARM is that they are considered to be “riskier” due to the fact that the interest rate will more than likely increase after the initial fixed-rate period ends. Because of this, as you probably guessed, your monthly payment will increase as well. Although there is a cap on how much the interest rate can go up, the first couple years after your fixed rate period ends, your monthly payment can go up significantly.
How Are Adjustable Rates Determined?
After the initial rate period ends, lenders determine what the adjusted rates will be based off of Treasury Securities, which are the most popular, as well as the national or regional costs of funds to savings and loan associations. When your loan is in the adjustment period, the rates are subject to a cap of how much they can increase. The cap on rates limits the risk associated with an ARM loan, and usually applies to 3 characteristics of the loan. The 3 characteristics of the mortgage include: frequency of the interest rate change, periodic change in interest rate, and the total change over the life of the loan, which is sometimes called the “life cap”.
ARM loans are a great idea if you are looking to purchase a home or condo and not planning on staying there long. The best part about an ARM is that you can save a good amount of money during the fixed rate period because interest rates on ARMs are lower than fixed-rate mortgages during this period. ARM loans are becoming more popular and more and more borrowers are taking advantage of their benefits.
If you are in the market for a new home or condo, Total Mortgage offers great rates on ARM’s and other mortgages. Mortgage Rates are at 14 month lows, so contact one of our licensed loan officers to find out how much you can save today.