Adjustable-rate mortgages (ARM)
An ARM is a mortgage with an interest rate that may vary over the loan term — usually in response to changes in the prime rate or Treasury Bill rate. The interest rate adjustment aims primarily to bring the interest rate on the mortgage in line with market rates.
Mortgage holders are protected by a ceiling, or maximum interest rate, which can be reset annually. As a result, ARMs typically begin with more attractive rates than fixed-rate mortgages — compensating the borrower for the risk of future interest rate fluctuations.
Choosing an ARM is a good idea when:
- Interest rates are going down
- You intend to keep your home less than five years
With an ARM, there is a chance that changes in the index may lead to a lower interest rate, but more often, any borrower choosing an ARM should be prepared to see their payments increase. ARM’s carry an interest rate cap, protecting the rate going too high above industry average rates. However, the payment will likely go up after the initial introductory period.
The main risk with an ARM is that a borrower could get used to a lower payment, and suddenly the rate will go up, making the monthly payment much higher. Therefore, a borrower who chooses an ARM should plan for this and have adequate resources in reserve or be confident that their income will rise substantially before the rate adjusts.
Some borrowers may choose to refinance prior to the loan adjusting. In this case, they need to be clear on the specifics of their loan. Some ARMS carry a pre-payment penalty which could affect the homeowner’s ability to refinance. They will also have to pay closing costs again when refinancing, which can be anywhere from 3-6% of the loan amount.
The lower interest rate on an ARM gives them the flexibility to take the savings on their monthly payment and put it towards the principal in the introductory period, thereby paying off some of the loan balance.
ARMs are still more commonly used if a homeowner doesn’t plan to be in their home long term. If used properly, they are a great option to finance a home.
To learn more about the specifics of this mortgage program, contact one of our experienced loan officers.