Chances are that at some point in your life you have heard the term “adjustable-rate mortgage”—a.k.a. ARM—and probably wondered what it actually is or why it matters. With rates on the rise, understanding how an ARM works could help you afford a home and widen your home loan options.
WHAT IS AN ADJUSTABLE-RATE MORTGAGE?
An adjustable-rate mortgage is exactly what it sounds like, but also so much more. An ARM is a home loan option with an interest rate that varies over time as the market rate changes. You get an initial interest rate that is typically more favorable than the market rate for a fixed-rate mortgage. This initial rate is set for a certain amount of time depending on the ARM option you choose. When the fixed period has passed, the interest rate will get larger or smaller along with the market rate at that time.
Borrowers typically choose an ARM when they know they don’t plan on living in that home forever. The terms of ARMs offer a variety of options to borrowers who want to stop renting and start building equity but know they may only be in an area for a few years. Now that you know what an ARM is, it’s time to learn how it works.
HOW DOES AN ADJUSTABLE-RATE MORTGAGE WORK?
An ARM is a great mortgage option for when you know you won’t be in your forever home. To accommodate different loan needs, we offer a wide array of ARM options including 5/6, 7/6, 10/6 and 15/6 terms. Looking at those numbers and thinking “I haven’t dealt with fractions in a long time”? You wouldn’t be the first to need a little more explanation. Here is how an adjustable rate mortgage works.
The first number of the term is how long your introductory term lasts, the second one represents how often the rate will change after the initial rate period. Let’s use the 7/6 as an example. If you qualified for a 7/6 mortgage, you would pay the initial mortgage rate on your loan for seven years. Once those seven years are up, your interest rate will change according to market rates every six month. That means if the market rate goes up so will your interest rate, BUT if the market rate goes down your interest rate will follow suit. It’s worth noting that no matter which direction in which your rate adjusts, it only applies to the remaining years and balance of your mortgage.
Even though ARMs eventually change, there are safeguards put in place to protect you from run-away interest rates. Our ARM home loans have an adjustment cap to limit how much the interest rate can adjust in one period, as well as a lifetime cap to curb how much the interest can change over the life of your loan.
WHAT ARE THE BENEFITS OF GETTING AN ARM?
Adjustable-rate mortgages come with a host of benefits for borrowers. The main benefit is the initial lower interest rate, however these benefits are great too:
Affordability—Along with a lower initial interest rate, you could also get a lower starting monthly payment. Both of which could help you to afford your mortgage payment. These lower rates also allow you to pay more toward your principal, giving you the possibility of paying less in return over time.
Flexibility—Life happens and you may not have the same circumstances you did when you began your home search. Whether you are looking for a larger home, relocating for work, or buying for any other reason, an ARM can help you get your foot in the door.
Ready to discover how an adjustable-rate mortgage could work specifically for your finances? Contact your local PrimeLending loan expert today for more information.
