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ARMs

ARM is the common abbreviation for an adjustable rate mortgage. The defining characteristic of this mortgage type is that the interest rate is not fixed for the life of the loan. Instead, the rate is changed, or adjusted, at a specified time, in accordance with an index selected when the loan is entered into. The ARM is a popular choice as a principal mortgage for many because its initial rate is lower than fixed rate mortgages, resulting in lower monthly payments at the beginning of the loan. These lower payments allow many borrowers to afford a larger loan than would have otherwise been possible.

However, lower initial rates and payments are only part of the ARM story. There are other factors in ARMs that aren’t present in other mortgages. One of these is the margin. This is the amount of interest your lender adds to the index, and represents his profit on the loan. For example, if the margin is at two percent and the index is at four percent at the time of adjustment, your interest rate will be six percent.

Another aspect of ARMs is the adjustment periods. The initial adjustment period is usually longer than the general adjustment period. Both periods are given in the name of the loan – for example, a 3/1 ARM means that the initial rate will stay in affect for three years, and the rate will be adjusted again every year until the end of the loan.

If you have been following this discussion closely, you may wonder why anyone would ever choose an ARM. After all, doesn’t the risk of skyrocketing interest rates offset any initial advantage of an ARM? This would seem to be the case, but isn’t always so because of another ARM feature – rate caps. All ARMs have a cap on the maximum amount of interest that can be charged over the life of the ARM.

For example, your ARM may state that you will never be charged over twelve percent interest. Some ARMs also have periodic caps, limiting the amount your ARMs interest rate can increase at each adjustment. However, be warned that if the rate increases by more than the cap, the remainder of the increase can be added at the next adjustment.

Overall, ARMs do represent an additional risk to those choosing this type of loan as their principal mortgages. However, you may decide that the risk is worth the lower initial rate and payments. You should always consider the worst case scenario when determining if an ARM is the right option for you.


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