How Do Adjustable Rate Mortgages Work?

What Is An Adjustable Rate Mortgage?

An adjustable rate mortgage, also known as an ARM, is sort of a combination of a fixed rate loan and a floating rate loan. Initially, the interest rate is fixed, but only for a limited period (most commonly, 5 years). After that period ends, the rate changes or resets to the prevailing market rate and continues to do so at predetermined intervals such as annually, every six months, quarterly or even monthly.

An ARM's Allure

What is enticing about an ARM is that it typically starts with the borrower locked in at a lower rate than a traditional fixed rate mortgage. So you could save money over a fixed loan for the first 5 to 7 or even 10 years, which is a great advantage, especially if you do not intend on living in the property long.

On the other hand, once that fixed period is over, you are at the mercy of the market.

The Risk

Being at the mercy of the market may be positive or negative. If the market rates are lower, you could save even further. If they go up, be prepared to pay considerably more than what you are accustomed.

Typically, ARMs are more appealing when interest rates are high because they will likely get lower over time, whereas, when interest rates are low, the likely trend is for them to rise over time.

How To Make The Best Decision

1. Look at your finances.
2. Do the appropriate research
3. Plan your budget
4. Make the choice that is best for you.