What Is an ARM Loan

When shopping for a mortgage you may find yourself wondering what is an ARM loan -- and if it is the best mortgage option for you.

ARM an acronym for adjustable rate mortgage. An ARM loan is also known as a variable rate mortgage or a floating rate mortgage. While a fixed-rate mortgage’s interest rate stays the same for the life of the loan, an ARM loan's interest rate changes periodically. An ARM loan typically has a lower initial interest rate than a fixed rate mortgage loan. Just because an ARM loan usually offers a lower fixed rate initially, however, borrowers must remember that the initial interest rate period is followed by adjustment intervals.

After you’ve answered the initial question, "What is an ARM loan?" you’ll want to understand how the adjustable rate mortgage loan you’re considering would work over the long term. The interest rate on an adjustable rate mortgage is made up of two parts: the index and the margin. Payments are affected by caps or limits which control how high or low rates can go. If the index rate moves up, so does your interest rate in most cases, and many times borrowers will be required to make higher monthly payments.

On the other hand, if the index rate goes down, your monthly payment could go down, but not all ARMs adjust downward. This is why it is important to read and understand information pertaining to the specific loan under consideration. Once the rate is adjusted, loan payments are subject to change based on the new interest rate. This is an important consideration when choosing an ARM loan. On the front end, the mortgage broker or lender takes on the risk and as adjustments are made in the rate, the risk shifts from the lender to borrower.

What is an ARM loan? It’s an opportunity to obtain a mortgage loan when unpredictable interest rates make getting a fixed-rate loan difficult. Is it right for you? All these loan choices make shopping for a mortgage a little more complicated than it used to be. Even among adjustable rate mortgages, not every ARM loan offers the same interest rate. As you research ARM loans, compare terms of various ARM loans and even weigh advantages and disadvantages against what a fixed-rate mortgage has to offer.

When you do your homework, you may be surprised to learn that an ARM could be less expensive over a long period than a fixed-rate mortgage. This could occur if interest rates remain steady or even move lower.

As you take all of this information into consideration, it’s wise to calculate the maximum amount by which the monthly payment could increase and weight it against your ability to make the higher payments in the future. The drawback is that your payment is not fixed. Online adjustable rate mortgage calculators can help you to see the big picture by helping to determine what your adjustable mortgage payments may be.

The length of time you plan on living in the house should be taken into consideration. If your job requires you to relocate on a regular basis, then rising interest rates may not even pose a problem because it would be time to sell your home before the loan rates adjust. But if you plan to stay in the home for years to come, other questions you may want to consider as you decide if an ARM loan is right for you include:

• What is the highest interest rate allowed by the mortgage?
• Will your income be enough to cover the payment now and in the future if interest rates rise?
• What is the interest rate cap?
• What terms are offered for the number of years over which you will repay the ARM loan and what are the benefits of each?
• What is the expected adjustment and when will it occur? This amount is added or subtracted from the interest rate.
• Do you plan on accruing any other sizable debts in the near future?
• Do you plan to pay the loan off early and if so will you be penalized?

Initial rates and ARM payment amounts remain in effect for a limited period of time. This time rages from as little as one month or can be as long as five years or more. Adjustable rate mortgages’ initial rates and payments can vary quite a bit from the rates you’ll pay later in the loan term. Even when interest rates are stable, your rates and payments may change. When lenders quote initial rates and the payment amount that will be due on a loan, it’s wise to ask them for the annual percentage rate (APR). If the APR is considerably higher than the initial rate, there’s a good chance that your rate and payments will be a lot higher when the loan adjusts.

Sometimes the desire to own a home can overcome common sense. Take your time and consider the possibilities now and in the future. Think about possible job relocations and lifestyle changes, such as a growing family or, on the other end of the spectrum, downsizing after children move out. Don’t be in such a rush that you make a poor choice. Instead, do your research and make an informed choice when choosing between adjustable rate mortgages or a fixed rate mortgage.

by Donna Sunblad

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