Adjustable Rate Mortgages

I want to talk about adjustable rate mortgages. So what is an adjustable rate mortgage or ARM?

The reason why I wanted to talk about this, is even though rates are remaining at historic lows right now, and rates are super, super low, it’s inevitable that rates at some point will go up. When rates go up in a rising interest rate environment, in a higher interest rate environment, ARMs become more attractive. What happens is typically the spread, or the difference between a fixed rate mortgage and an ARM rate becomes larger as rates get higher. Right now, ARM rates are almost the same as fixed rate mortgages, maybe a little bit lower, so it’s not quite as attractive to consider it.

Now, just using the term adjustable I know can seem maybe kind of scary, because you don’t want your mortgage rate and your payment to change from month to month. Actually that is somewhat true about ARMs, but there’s an aspect of an ARM that creates some safety, and that is most ARMs when they’re tied to your house, are fixed for a certain period of time. A very common time period is a five year ARM.

So what that means is, that means the ARM is fixed for five years at the interest rate you lock in and the rate cannot change. You know that you’re guaranteed that payment for five years. After that, the rate can adjust, but there’s what are called caps that limit how much the ARM can adjust.

It can adjust 1% each year, 2% each year. It can’t just go through the roof all of a sudden in one year. And the thing to know too, is that depending on where rates are, your rate actually could go down at an ARM also. It doesn’t just only go up, because it’s based on prevailing rates. So ARMs typically have a fixed portion that’s called the margin, and then it has added to that each time when it adjusts, what’s called an index, and that index is the variable portion of the ARM, and that’s tied to different indexes depending on the ARM. And what I’m trying to say is, depending on what the market’s doing that determines the rate.

Typically also once an ARM adjusts, it’ll stay at that rate for another year, or sometimes longer, but typically a year. So you know that then for that next year you have that payment. So ARMs aren’t necessarily super scary. And going back to the beginning of this talk, if the spread between a fixed rate loan and an ARM loan is a large spread, it’s something that may be worth looking at, because that savings over the course of five years, for example, could outweigh the risk. And there’s a lot of reasons why over the course of five years, or seven years, that’s another common term, or common length for an ARM, for the fixed period of an ARM.

A lot of things can happen over five or seven years to where you might end up refinancing, you might end up selling the house and moving, or there might be other reasons why you need to refinance, pulling cash out to do home improvements or whatever the case may be. So you might not even have that ARM for longer than the fixed period. So these are reasons why sometimes ARMs are a wise thing to at least look at when you’re considering your financing options. So I hope that helps you out, give me a call if you have any questions on that, or want to look at your options for a home loan.