What is an Adjustable Rate Mortgage (ARM)?
An ARM (adjustable rate mortgage) is a loan that initially has a low-interest rate, but the rate can increase after a certain amount of time. For example, an ARM may have a fixed period of 5 years at 3% interest. For the first 5 years the loan interest rate will be 3% but after the five years are up the interest rate can adjust up or down depending on what the current interest rates are. ARMs can be a great option but you need to be careful with them and some of the mortgages are set up very risky. ARMs were a huge contributor to the last housing crash, so now it’s kind of tough to try and to get a loan at the moment. A 5/30 year ARM is a 30 year loan with an initial rate that is fixed for the first five years but can increase on the sixth year. There is a certain amount that the loan tops out at for how much the interest rate can increase after the adjustment period, and a minimum it can go down. An ARM can adjust up or down depending on where interest rates are when the loan adjusts. Most ARMs will have a 3 to 10 year fixed period. In the past, there have been ARMs with 6 month fixed rate periods and the interest would increase after those 6 months concluded. These were some incredibly risky loans and many consumers had no idea what they were getting themselves into. At the moment it’s almost impossible to get a loan of that measure with the government getting strict on regulations after the last crash.
Are Adjustable Rate Mortgages Risky?
An ARM will tend to have a lower interest rate than a fixed mortgage. A 30 year fixed rate mortgage would have the same rate for 30 years. If the rate on a 30 year fixed rate loan is 3%, the rate on a 5/30 ARM might be 2.5% or lower. The real advantage is when interest rates are higher. When rates were 5% the rate on an ARM might be 4%, which can save hundreds of dollars a month and thousands of dollars a year. When rates get really low, in the 2 and 3% range an ARM may not have much lower of a rate than a 30-year fixed loan. There probably isn’t an advantage to using ARMs when rates are super low, but you’ll want to have that low rate locked in as long as you can. ARMs have gotten a bad wrap due to the amount of loans that were foreclosed on during the housing crisis. The reason so many people lost their homes with an ARM was their qualification timing on the low initial interest rate. When the rate on the adjustable-rate mortgage went up, homeowners couldn’t afford the payment. If you’re thinking of getting an adjustable-rate mortgage, plan accordingly in case the payment increases, even if you think you will have the loan paid off by then. Don’t depend on being able to refinance to get yourself out of the payment.