Is an adjustable-rate mortgage right for you?
Before you find your dream home, you’ll probably need to find a home loan. There are several different types of home loans, so it’s important to find one that’s best for your unique financial situation. The most common type of mortgage is a fixed-rate mortgage; however, as interest rates rise, adjustable rate mortgages are gaining in popularity.
What is an adjustable-rate mortgage (ARM)?
An adjustable-rate mortgage (ARM) is simply a home loan with an interest rate that changes periodically.
How is an adjustable-rate mortgage different from a fixed-rate mortgage?
The difference between an ARM and a fixed-rate mortgage is that the interest rate on an ARM varies over time, while rates on a fixed-rate mortgage remain the same for the life of the loan. The trade-off is that, at least for the introductory period, interest rates for ARMs are generally lower than rates for fixed-rate loans. To compare current rates, click here.
How does an ARM work?
ARMs begin with an initial introductory rate that is usually lower than interest rates on a fixed-rate mortgage. The initial rate can be locked in for different periods of time—usually between one and 10 years. After the initial introductory period, the rate will adjust periodically.
What determines the future rate of an adjustable-rate mortgage?
The rate of an adjustable-rate mortgage is based on two components: market index and margin. The market index is a benchmark rate determined by general market conditions. The most common index used is the one-year London Interbank Offer Rate (LIBOR), which is the rate used by most international banks. The margin (a percentage) is established by the mortgage lender at the time you apply for your mortgage.
Why use an adjustable-rate mortgage?
For some homebuyers, it might make sense to use an ARM when interest rates on fixed-rate loans don’t allow them to secure the loan amount they’re looking for. ARMs are especially beneficial to first-time homebuyers who know that they will be able to afford larger monthly payments in the future. Homebuyers who know that they will sell or refinance their loan in a few years may also consider an ARM.
How do I know if an ARM is right for me?
Whichever loan type you choose, it's important to consider that lifetime cost of the loan. If you’re not sure if an ARM is right for you, discuss your options with your mortgage lender. If you don’t have a mortgage lender, your REALTOR® can refer you to several lenders from which to choose.