Adjustable Rate Mortgages Explained

Learn the adjustable rate mortgage basics. New options are available now.

Take a moment to have adjustable rate mortgages explained plainly for you. In today's home loan arena, low adjustable rate mortgages are taking some heat. Find out why.

Definition of adjustable rate mortgage

One type of mortgage loan available is the adjustable rate mortgage or ARM for short. An ARM is nothing like a fixed rate mortgage where you have a specific rate throughout the term of the mortgage. With an ARM, the rate can change periodically and can result in higher payments. That is what is meant by "adjusting", the payment along with the interest rate adjusts (usually up).

An adjustable rate mortgage usually has a period at the beginning of the loan with a fixed rate. After this initial period, called the introductory period, the adjustable rate mortgage rate will be adjusted regularly, according to a planed schedule. The schedule of when the rate will adjust is agreed upon at closing. This can be as soon as one month or as long as 10 years. Be sure to read the fine print and ask questions.

How often do they adjust?

The most popular ARM used to be a one-year adjustable rate mortgage, which takes its first adjustment after one year. This type of low adjustable rate mortgage was the standard form of these types of loans. Now there are hybrid ARMs available. You will know these by their lengthy fixed rate periods, typically from 3 to 10 years. These are named by their fixed / adjustable ratios.

For instance, a 3/1 adjustable rate mortgage has a fixed rate for the first three years and will adjust annually thereafter. Since these loans are based on a 30 year term, the rates are adjusted for 27 years.

The rates are adjusted using any one of several indexes. Having adjustable rate mortgages explained, according to the yields, including the most popular ones are the Weekly constant Maturity Yield on the one year Treasury bill, the 11th district Cost of Funds Index (COFI) and the London Interbank Offered Rate (LIBOR). Basically, your rate is calculated based on the current index plus a margin. For this reason, the rates are typically lower on ARMs than for fixed rate mortgages, but the danger of a higher payment is always on the horizon.

Every time the adjustment date rolls around, your payments are re-figured. Since the rates are influenced by market indexes, your interest could rise which would increase your payment. Depending on the increase in rate, this could be drastic in some cases. Of course, an adjustable rate mortgage ARM may adjust down, as well.

Is a low adjustable rate mortgage right for you? So with the obvious pitfalls wrapped up in adjustable rate mortgages, how did they get popular and why would a buyer consider one opposed to a fixed rate loan?

Adjustable rate mortgage loans became popular during a period of recession in the economy. In a time when market rates were low, the ARM was beneficial to the consumer at the time. The rates on ARMs are typically lower than for fixed rate loans. As a rule, people will only look at the interest rate while ignoring the additional index that is added or the fact that their rate will adjust in 3,5,7 or 10 years.

Is an ARM good for short term loans?

Yes! Adjustable rate mortgages can be used in situations where the buyer is looking for a short-term loan. Perhaps a buyer is looking at a possible job change or will be leaving the country in a couple of years. These buyers can take advantage of the lowered interest rate offered on an ARM without worrying about the adjustment period.

In any case, it is important that you have adjustable rate mortgages explained by a qualified loan officer and READ the terms carefully to understand what you are agreeing to.

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