What is an Adjustable-Rate Mortgage (ARM)?
If you’re shopping around for a mortgage, you may come across articles, bank offerings, or lenders talking about Adjustable-Rate Mortgages. But what is an Adjustable-Rate Mortgage, what are the benefits of an Adjustable-Rate mortgage, and how can a flexible mortgage rate help you get the keys to your dream home?
An Adjustable-Rate Mortgage, or ARM, is a type of mortgage loan that offers homeowners greater flexibility in their house hunt. These loans typically start out with a lower-than-market interest rate, with the caveat that the interest rate will change over time in an ARM loan. Meaning this is different from the type of mortgage you may be more familiar with – a Fixed Rate Mortgage – where the interest rate remains the same over the life of the loan.
You may also see Adjustable-Rate Mortgages referred to as “Hybrid Mortgages” or “Hybrid Adjustable-Rate Mortgages.”
Over the course of this article, you’ll find ARM mortgage explained as we explore all this innovative product has to offer.
Want more tips on searching for the perfect mortgage? Try our Mortgage 101 rundown or check our guide to the Homebuying Journey.
Types of ARM
As you research ARM mortgages, you may come across terms like 3/1, 5/1, 7/1 or ten-year arms. Since an Adjustable-Rate Mortgage works by offering buyers a combination of fixed and flexible interest rates, these different terms denote how long the initial fixed interest rate will last, as well as how often the interest rate will adjust after that – such as a 7-year arm. Meaning the interest rate is fixed for seven years.
For example:
- 7/1 ARM. Meaning the interest rate is fixed for seven years, and then is adjusted once per year based on market rates.
- 3/1 ARM. Meaning the interest rate is fixed for three years, and then is adjusted once per year based on market rates.
- 5/1 ARM loan. Meaning the interest rate is fixed for five years, and then is adjusted once per year based on market rates.
Once your hybrid mortgage enters the adjustable period, your interest rate can vary widely – it could be less than that initial, fixed rate, or it could be much higher. However, this type of mortgage does bring some unique benefits to homeowners and can be a great choice for some.
What are the benefits of an Adjustable-Rate Mortgage?
So, what is an advantage of an Adjustable-Rate Mortgage? One of the biggest benefits of ARM mortgage is that the initial interest rate is typically much lower than current market rates. This can make a hybrid mortgage extremely accessible to people who need a little boost to achieve their homeownership dreams. A lower interest rate means a lower monthly mortgage payment, which can give young families or those wanting to put down roots time to settle in and build equity and some financial stability before their ARM enters its flexible period.
And, if the market interest rate is lower than in previous years, you’ll have an extra financial windfall that you can add to savings, put towards projects, or use to plan a vacation!
What are the disadvantages of an Adjustable-Rate Mortgage?
What are the disadvantages of an Adjustable-Rate Mortgage? Simply put, a Hybrid Mortgage can put you at the mercy of the markets. Once your fixed rate period expires, it can be extremely difficult to plan and budget for your annual interest rate adjustments.
If your interest adjusts to a much higher rate, your monthly payment can substantially increase – and you will need to be able to pay that amount for the entire year.
Adjustable-Rate Mortgage: Pros and Cons
Now that you know a little bit more about Hybrid Mortgages, it’s time to explore Adjustable-Rate Mortgage pros and cons.
The pros and cons of an Adjustable-Rate Mortgage include:
Pros : Flexible loan terms, Lower initial payments
Cons: Uncertainty can make it difficult to budget; More complex loan terms; Unpredictable monthly payments
Who is an Adjustable-Rate Mortgage best for?
After examining the pros and cons of ARM mortgage, who is a good candidate for a Hybrid Mortgage? An ARM can be a good choice for buyers who are looking for a short-term break in a tough market.
For example, if you need to purchase a home, but not stay there long-term. An Adjustable-Rate Mortgage is a good choice for buyers who plan to move before their fixed-rate term ends.
It can also be a good choice for buyers who want to score a lower rate in a high-interest rate market, and who hope to refinance their home once interest rates drop – usually before their fixed-rate term ends.
Is an Adjustable-Rate Mortgage right for me?
Now that we have ARM mortgages explained, it’s time to determine if one is right for you. You can get real-time examples of what your monthly payments with an ARM might look like using our helpful ARM calculator.
You can also talk with your attentive mortgage loan officer to determine if an Adjustable-Rate Mortgage suits your needs.
As with any financial decision, it’s important to ask questions, research all options and weigh the pros and cons before choosing a mortgage loan solution.
Explore other mortgage options with our suite of mortgage calculators.
FAQs
Are ARM mortgages a good idea right now?
The interest rate market is always in flux, so it can be difficult to determine if any current market is, so to speak, ideal. If you’re considering an ARM, often what is more important are your own life circumstances. Talk with your mortgage loan officer to determine if an Adjustable-Rate Mortgage suits your current needs. For example, are you wanting to buy a house but plan to move or refinance within a few years? Then an ARM might be right for you.
Can you refinance from ARM to fixed?
Yes. You can refinance your ARM to a fixed-rate mortgage at any time, as long as you qualify for a refi.
Do Adjustable-Rate Mortgages have PMI?
Adjustable-Rate Mortgages can have Private Mortgage Insurance (PMI). Whether or not your mortgage has PMI is determined by your down payment amount – not the interest category of your mortgage. If your downpayment is less than 20 percent of the sale price of your home, it is likely you will need to pay PMI. Interested in a mortgage with no PMI? Check out our Next Horizons Mortgage program.
How high can an Adjustable-Rate mortgage go?
Interest rates in an Adjustable-Rate Mortgage are determined by the market rate at the time of your rate adjustment. This means if the market is at 11 percent interest when your rate is adjusted, you will pay 11 percent interest on your mortgage until your next adjustment. Your rate can go as high as the market – but this also means it can drop to accommodate for historically low rates, as well.
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