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An adjustable-rate mortgage (ARM) is a home loan with an interest rate that can change periodically based on an established index, such as an economic indicator, stock market indicator or other benchmark. ARMs are also known as variable rate or floating mortgages and are often attractive to homebuyers who plan to stay in their home for a limited period of time or who can afford potential increases in their interest rate.
Unlike a fixed-rate mortgage, in which the interest rate remains the same for the duration of the loan, the interest rate on an ARM may go up or down depending on the performance of the index. The index rate is how lenders measure the estimated cost of money at any given moment, and the interest rate and payments of an ARM are tied to the index.
When the index rate rises or falls, so does the interest rate and monthly payments on the ARM loan. An ARM can potentially be advantageous; depending on the index, the initial rate on an ARM loan may be lower than the initial rate of a fixed-rate loan. Consumers who plan to stay in their home for a short time may be able to save a significant amount in interest by taking out an ARM loan.
However, an ARM can also be disadvantageous, as the rate on the loan can increase significantly over the life of the loan. For this reason, many ARM loans include rate caps that limit how much the interest rate or payments can increase per year, or over the entire life of the loan. Additionally, some ARM loans have a "Life of Loan Cap" which limits how much the interest rate, but not necessarily the payments, can increase over the life of the loan, regardless of the index performance.
It is important to carefully consider the terms of an ARM loan before signing the mortgage documents. ARMs can be a good option for borrowers who anticipate rising interest rates, plan to stay in their home for a short period of time and have a relatively high payment capacity should rates rise beyond their personal comfort zones. However, the varying mortgage rate and payment amounts of an ARM can be beneficial for some, but may be too much of an unpredictable risk for others.
Unlike a fixed-rate mortgage, in which the interest rate remains the same for the duration of the loan, the interest rate on an ARM may go up or down depending on the performance of the index. The index rate is how lenders measure the estimated cost of money at any given moment, and the interest rate and payments of an ARM are tied to the index.
When the index rate rises or falls, so does the interest rate and monthly payments on the ARM loan. An ARM can potentially be advantageous; depending on the index, the initial rate on an ARM loan may be lower than the initial rate of a fixed-rate loan. Consumers who plan to stay in their home for a short time may be able to save a significant amount in interest by taking out an ARM loan.
However, an ARM can also be disadvantageous, as the rate on the loan can increase significantly over the life of the loan. For this reason, many ARM loans include rate caps that limit how much the interest rate or payments can increase per year, or over the entire life of the loan. Additionally, some ARM loans have a "Life of Loan Cap" which limits how much the interest rate, but not necessarily the payments, can increase over the life of the loan, regardless of the index performance.
It is important to carefully consider the terms of an ARM loan before signing the mortgage documents. ARMs can be a good option for borrowers who anticipate rising interest rates, plan to stay in their home for a short period of time and have a relatively high payment capacity should rates rise beyond their personal comfort zones. However, the varying mortgage rate and payment amounts of an ARM can be beneficial for some, but may be too much of an unpredictable risk for others.