What Is an ARM Loan?
An adjustable rate mortgage (ARM) loan has a variable interest rate, typically tied to a financial index. Such a loan may help you afford a home, but could cost more in the long run than a fixed-rate loan.
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History
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ARM loans gained notoriety in the 1970s and 1980s because of the high rate of inflation and subsequent high interest rates. ARMs' share of the mortgage market reached its peak in 1984 with 62 percent. The popularity of ARMs dipped to an all-time low of 3 percent in 2009 due to historically low interest rates.
Benefits
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An adjustable rate mortgage usually has a very low interest rate so the debtor can afford to acquire a house or get a more expensive house than he could otherwise.
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Types
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ARMs usually come with a 30-year term that updates the interest rate every one, three or five years, depending on the negotiated contract. Some may even fix the rate for the first couple of years and then turn into a one-year ARM for the rest of the life of the contract.
Interest Rate
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Interest rates on an ARM loan are usually set based on the London Interbank Offered Rate (LIBOR) or the 1-year U.S. Treasury Bill. The lender adds the rate of the financial index to its profit margin, which can vary widely depending on your credit rating.
Considerations
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The total monthly payment on an ARM can shoot up drastically within a year. For example, a $954.83 initial monthly payment, at 4 percent interest, would rise to $1,192.63 after the discount period ends and the interest rate goes to 6 percent. Consumers shopping for a mortgage should estimate if they will be able to afford higher payments after the discount rate.
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References
- Photo Credit Image by Flickr.com, courtesy of Jeff Turner
