What is an Adjustable Rate Mortgage or ARM?
Adjustable rate mortgages (ARM) are the opposite of fixed rate – with an ARM, the rate fluctuates or “adjusts” after an agreed-upon period of time. This adjustment is made according to a rate index, and the index used varies by lender.
ARMs are desirable for people who expect their income to go up three to seven years in the future, or people who do not expect to live in their home for very long and plan to re-sell it. Sometimes people obtain an ARM with its lower initial rate and lower monthly payments, keep it until the fixed rate is about to expire, and then refinance to a fixed rate mortgage.
Fortunately, in the United States, there is a “cap” on how high your payments can be adjusted, and this will be specified in the loan agreement. Basically, the borrower benefits if interest rates fall but loses if interest rates rise.
There are three main types of adjustable rate mortgages:
3/1 ARM – The loan is “fixed rate” for three years, but adjusts or fluctuates in the last 27 years.
5/1 ARM – The loan rate is fixed for five years, but adjusts in the remaining years.
7/1 ARM – The loan rate is fixed for seven years, but adjusts the remaining years.