- An adjustable rate mortgage (ARM) is one with an interest rate that changes. Many ARMs have low a APR to start with, resulting in lower monthly payments, when compared to fixed rate mortgages. The interest rate may change from year to year, resulting in higher interest and mortgage payments. Some ARMs are structured in such a way that does not allow the rates to adjust down, only up. In addition, it is important to note that many ARM have pre-payment penalties, which means that paying them off early can result in high fees.
- Most adjustable rate loans will have an initial interest rate period in which the interest rate and payment stays the same. This period may be between one month and up to five years. At the time of the initial rate expiring, the interest rate may rise, even if interest rates nationally are stable. The amount of change will range from as low as 0.05 percent up to 2 percent or sometimes more.
- The adjustment period of an ARM is the amount of time in between each rate change. Some loans adjust monthly while others will only adjust once every two to five years. These periods are defined by the mortgage terms. Often, the loan is described using the adjustment period, such as a 2 year ARM, meaning the ARM will adjust every two years.
- To determine how much the adjustments will be, lenders use index and margin figures which determine the interest rate charged to you. The index is the measurement of interest rates themselves. Then, lenders add an extra amount called a margin for their fees. In some ARMs, there is a cap, or a maximum that the loan will adjust. There may also be a minimum adjustment requirement, or the minimum that the loan will adjust.
- Homeowners need to protect themselves from ARM pitfalls. It is important to realize that these loans may adjust significantly, resulting in a much higher monthly payment. Read all terms of the ARM before agreeing to them. This will ensure that the borrower can still make payment if an ARM adjusts to its highest level. Some lenders or mortgage brokers use deceptive tactics to lure in potential mortgage buyers with falsely low interest rates or unexplained terms. Be sure you are fully aware of the terms of the ARM and work with an attorney to ensure the loan is fully understood.
