While fixed-rate loans are one of the most popular choices for mortgage loans, there is another choice: the adjustable-rate mortgage or ARM loan. If you’ve ever wondered what an ARM loan is or why anyone would want one, here is what you need to know:
An adjustable-rate mortgage is a type of home loan with a short fixed-rate period, after which the interest rate is allowed to adjust periodically based on certain market indexes.
An ARM loan comes with an initial low-rate period of anywhere from one to ten years. During that time, your interest rate will be fixed and the monthly payments will all be the same. When that teaser rate period is up, the interest rate will track a specific index, like the Cost of Funds Index or the London Interbank Offered Rate (LIBOR.) There are rate caps set to limit how much your interest rate can rise in a given period. For example, the initial adjustment cap limits how much your rate can increase for the first time, usually between 2%-5%. There are also periodic caps that limit how much your rate can change from year to year and lifetime caps that keep your rate from climbing past a top threshold over the life of the loan. And finally, there can be payment caps that keep your payment from rising above a certain dollar amount each month.
While there are some reasons to be cautious, when well-understood adjustable rate mortgages can provide some borrowers with the specialized loan fit they need.