An adjustable rate mortgage (ARM) is a type of home loan where the property being purchased serves as collateral. Unlike a fixed-rate mortgage, where the interest rate remains constant throughout the loan term, an ARM features a fixed interest rate for an initial period that typically ranges from three to ten years. After this introductory period, the interest rate adjusts periodically, either increasing or decreasing, for the remainder of the loan term.
For instance, a 3/1 ARM locks in your interest rate for the first three years, and then it adjusts annually for the next 27 years, assuming a standard 30-year loan term. Other popular options include 5/1, 7/1, and 10/1 ARMs.
The initial interest rate of an ARM is generally lower than that of a fixed-rate mortgage, resulting in lower monthly payments at the beginning. However, these payments can increase if interest rates rise over time.
An ARM might be suitable if you anticipate one of the following scenarios:
– Interest rates will decline in the future
– You plan to refinance before the introductory period ends
– Your future income is expected to increase, making higher payments manageable
– You intend to sell your home before the initial interest rate adjusts
Conversely, an ARM may not be the best choice if:
– You prefer stability and are risk averse
– You are unsure about your future income growth
– You believe that interest rates will rise significantly in the future