Which Home Loan Is Right For You: Adjustable Rate Mortgage (ARM)

How to Decide if an ARM Is Right for You?

By: Janet Wickell

An adjustable rate mortgage, called an ARM for short, is a mortgage with an interest rate that is linked to an economic index. The interest rate, and your payments, are periodically adjusted up or down as the index changes.

ARM Terminology Index
An index is a guide that lenders use to measure interest rate changes. Common indexes used by lenders include the activity of one, three, and five-year Treasury securities, but there are many others. Each ARM is linked to a specific index.

Margin
Think of the margin as the lender's markup. It is an interest rate that represents the lender's cost of doing business plus the profit they will make on the loan. The margin is added to the index rate to determine your total interest rate. It usually stays the same during the life of your home loan.

Adjustment Period
-The adjustment period is the period between potential interest rate adjustments.
You may see an ARM described with figures such as 1-1, 3-1, and 5-1.
zSB(3,3)
-The first figure in each set refers to the initial period of the loan, during which your interest rate will stay the same as it was on the day you signed your loan papers.
-The second number is the adjustment period, showing how often adjustments can be made to the rate after the initial period has ended. The examples above are all ARMs with annual adjustments--meaning adjustments could happen every year.
If my payments can go up, why should I consider an ARM?
The initial interest rate for an ARM is lower than that of a fixed rate mortgage, where the interest rate remains the same during the life of the loan. A lower rate means lower payments, which might help you qualify for a larger loan.
How long do you plan to own the house? The possibility of rate increases isn't as much of a factor if you plan to sell the home within a few years.

Do you expect your income to increase? If so, the extra funds might cover the higher payments that result from rate increases.

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Posted in: Become A Home Owner