Are You Considering An Adjustable Mortgage Rate? Here's What You Need to Know About ARM Loans!

As mortgages continue to rise, more and more prospective buyers are considering an adjustable-rate mortgage loan as an option for financing their home purchase. As with any significant financial decision, buyer should carefully weigh the advantages and disadvantages of adjustable-rate mortgages. 

Unlike traditional fixed-rate mortgages, which have an interest rate that remains the same for the duration of the loan, ARM loans operate quite differently. Here is what you need to know about how they work and the benefits and drawbacks of engaging in one because they can sometimes be somewhat difficult.

A Deep Understanding Of ARMs
ARM (Adjustable-Rate Mortgage) is a loan whose interest rate is initially pre-determined for a set period before changing periodically. Often, compared to fixed-rate mortgages, the starting interest rate is cheaper. An ARM's interest rate will fluctuate once the fixed-rate period is over, depending on the index it follows, which implies that your monthly payments may rise or fall.

The financial industry sets the benchmarks, which are used to determine the rates that lenders use. Several indexes are available, and the loan documentation will specify the index your mortgage adheres to. However, it is difficult to predict interest rates as they have been trending upward and downward in recent decades in multi-year cycles.

Different Types of ARM
There are a variety of adjustable-rate mortgages available, and they are frequently identified numerically (for instance, 5/1 or 10/6). The first digit indicates the duration of your fixed-rate period, and how frequently the rate will fluctuate is indicated by the second number. The following are some examples of ARM loans:

• 5/1 ARM: The initial five years of the loan have a fixed interest rate. Over the following 25 years, the interest rate will change once a year.
• 10/1 ARM: The initial 10 years of the loan have a fixed interest rate. Over the following 20 years, the interest rate will change once a year. However, some mortgages do not currently provide 10/1 ARMs.
• 5/6 ARM: A fixed interest rate defines the loan's initial five years. The rate will then change every six months for the following 25 years.
• 7/6 ARM: For the first seven years of the loan, the interest rate is at a set amount. After that, for the following 23 years, the interest rate will change once every six months.
• 10/6 ARM: The initial 10 years of the loan have a fixed interest rate. After that, for the following 20 years, the interest rate will change once every six months.

How ARMs Compare to Fixed-Rate Mortgages
​​In contrast to ARMs, traditional or fixed-rate mortgages have interest rates that remain constant over the loan term, which could be 10, 20, or more years. They typically start with higher interest rates than ARMs, which can make ARMs more alluring and affordable, at least temporarily. On the other hand, fixed-rate loans guarantee that the borrower's rate won't rise to the point where loan payments might become too high to handle.

Furthermore, monthly payments stay the same with a fixed-rate mortgage. Yet, the amounts allocated to paying interest or principal will alter over time following the loan's amortization plan. Fortunately, homeowners with fixed-rate mortgages can refinance, settling off their old loan with a new one at a lower rate if interest rates fall generally.

When Should You Consider An ARM
Many homeowners opt for an ARM to benefit from the initially lower mortgage rates. If you intend to move or sell your house within five years or before the loan's adjustment period, or if the rates are high when you purchase your house, you might consider using an adjustable-rate mortgage. Additionally, obtaining a fixed-rate mortgage to secure the low rate would make more sense if rates were low.

Remember that there is some uncertainty regarding how much your monthly payment will increase or decrease with an ARM. Your rate may change and cause an increase in your monthly payments depending on the market. You must keep in mind that even if your rate increases, you are still obligated to make your monthly installments.