Adjustable-rate mortgages (ARMs) can be an attractive option for homeowners who desire greater payment flexibility, but it should be combined with a robust budget and long-term strategy in order to prevent paying too much interest over the life of the loan.
A popular type of ARM is the 5/1 ARM, which features an initial period during which the interest rate remains fixed and then adjusts annually for the remaining term of the loan. This adjustment may depend on various factors like the lender’s index or margin as well as market conditions.
Many ARMs use a benchmark index, such as the prime lending rate, to calculate your interest rate. This index takes into account various factors like current economic conditions and expectations for the future.
Mortgage lenders calculate interest rates based on an index by applying a “margin” that has been agreed upon between both parties. The margin may be fixed at some percentage point level or fluctuate based on changes to the index.
Variable-rate mortgages (ARMs) are a popular choice for homebuyers as they allow the borrower to pay less interest than with a fixed-rate loan during its introductory period, known as the “teaser” rate. However, these ARMs can become costly as interest rates increase.
Some ARMs feature a fixed interest rate for three, five, seven or 10 years that adjusts to a variable interest rate that may fluctuate over time. These “teaser” ARMs are less risky for banks than other types of ARMs with low initial rates followed by increases in your monthly payments.
Arms can also be tied to an interest rate, such as SIBOR or SOR of any duration. A spread is added to the X-month SIBOR or SOR to calculate the corresponding margin, which may increase over time as market conditions improve and borrowers are able to afford higher mortgage payments.
A reliable lender will explain how an adjustable-rate mortgage works and when switching to a fixed-rate loan might be best. Furthermore, be aware of ARM caps – limits on how much your interest rate can change between adjustment periods and over the life of the loan.
In the United States, there are various types of adjustable-rate mortgages. You have your choice between a fixed-rate ARM, an ARM with a fixed rate, or both.
When selecting an adjustable-rate mortgage, be sure to read its terms thoroughly and ask any queries you may have. Doing so could save you from regret if it turns out the loan isn’t suitable after all.
Common errors that can lead to ARM interest overcharges include selecting the incorrect index date, neglecting to include a margin or failing to enforce an interest rate cap.