An adjustable rate mortgage (also called an “ARM” for short) is a mortgage that comes with a variable interest rate, as opposed to the fixed interest rate that comes on most mortgages. This means that your monthly interest can fluctuate, resulting in your monthly payments going up or down according to current market conditions.
The most popular ARM in recent years is a fixed period ARM, sometimes called a “hybrid ARM”. These are based on a 30-year term, and begin with a specific fixed interest rate for a certain period of time. This period of time is usually 5, 7, or 10 years, depending on the type of ARM for you opt for.
For example, a 7 year ARM will be referred to as a 7/1 ARM, and the fixed interest rate it comes with will remain unchanged for the first 7 years that you pay off your mortgage. After these 7 years are over, the remaining 23 years of your 30-year payments will be subject to fluctuating interest rates. If you take out a 7/1 ARM mortgage with an initial fixed interest rate of 5% for example, you will pay back your mortgage payments at a 5% interest rate for the first 7 years. After this, you will continue to pay back your monthly payments, but your interest rate could go up and down. You could find your monthly interest rate dropping to 3%, or shooting up to 8%, for example.
Adjustable rate mortgages inherently have some risk to them, as you cannot always predict when interest rates are going to fall or skyrocket. You need to make sure that you will be able to afford your monthly payments if interest rates rise, as you may risk the foreclosure of your home otherwise.
If you want predictable payments, stable rates, and are planning on living in your new home for a long time, then a fixed-rate mortgage is probably the better option for you. Fixed-rate mortgages offer you the stability and predictability that you require for your lifestyle.
On the other hand, if this is a “starter home” for you and you plan to move out after a few years, then an ARM mortgage may be right for you. An ARM mortgage may also be appropriate if you believe that interest rates are due to drop, or if you are certain that you can comfortably afford any fluctuating payments.
Remember that variable interest rates are unpredictable, and a lot of the time they are more likely to go up than they are to go down. It should be no surprise that banks will want to extract as much money as you from possible, so they don’t tend to be kind when it comes to variable interest rates.
In most cases, a fixed-rate mortgage is a better option. If you do opt for an ARM, however, make sure that you are able to afford your monthly payments if interest rates rise, otherwise, you will risk repossession of your home.