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Lower initial interest

Adjustable-rate mortgage (ARM) loans provide a low interest rate for an initial payment period, making the initial monthly payments less than those a fixed-rate mortgage usually offers.

How an adjustable-rate mortgage impacts payments

After the lower initial rate period, the ARM loan's interest rate will adjust to a fully indexed rate, and it is likely that your rate and your payments will increase. If the rate goes up after the initial period, your monthly payments go up, so you want to be financially prepared to make larger payments.

ARM loans are available for a 30 year term. In addition to the term, ARMs have different options for how long the initial interest rate will last before the rate can start to adjust. So, for example, you could get a 7/1 ARM, and your interest rate and payment would stay the same for 7 years before being open to annual adjustment.

When you consider ARM loans, find out how and when your rate can change, because those factors will determine how much your monthly payment is.

Advantages of an adjustable-rate mortgage

Adjustable-rate mortgages are a good choice if you:

  • Are planning to move in a few years (before the end of the initial rate period) and therefore aren't concerned about possible rate increases
  • Expect your income to rise enough in the coming years to cover any increase in payments resulting from an increase in the interest rate
  • Want a lower initial monthly payments than a fixed-rate mortgage usually offers
  • Think interest rates may fall in the future

Some disadvantages of adjustable-rate mortgages:

  • Interest rates will increase in a rising rate environment
  • Increase in rates will increase payment amount, which may not keep pace with increase in income
  • Increase in interest rate will reduce accumulation of equity, especially where home values are declining, and may make it more difficult to refinance your loan

10/1 adjustable-rate mortgage

A 10/1 ARM has a fixed interest rate for the first 10 years. After 10 years, the rate can change once every year for the remaining

life of the loan. When the rate changes, your monthly payments will increase if rates go up and decrease if rates

7/1 adjustable-rate

A 7/1 ARM has a fixed interest rate for the first 7 years. After 7 years, the rate can change once every year for the remaining life of the loan. When the rate changes, your monthly payments will increase if rates go up and decrease if rates fall.

5/1 adjustable-rate

A 5/1 ARM has a fixed interest rate for the first 5 years. After 5 years, the rate can change once every year for the remaining life of the loan. When the rate changes, your monthly payments will increase if rates go up and decrease if rates fall.

Learn about ARM interest rate caps and indices

 

ARMs begin with a start rate, also known as the initial interest rate, which gives you a special low monthly payment for a set amount of time, such as 5, 7 or 10 years. After the initial rate period, the rate adjusts to a fully indexed rate, explained below, and it is likely that your rate and your payments will increase.

The rate you pay on an ARM after the initial rate is based on a fluctuating index plus a fixed extra amount, called a margin. For example, if the interest rate for the financial index was 5.5% and your margin was 2%, then your rate at the time of adjustment would be 7.5%. Keep in mind that different indexes go up and down faster than others, and both the index used and the margin can vary among lenders. How often your payments are adjusted based on the index, and how much rates and payments increase at each adjustment, depends on your loan terms.

ARM interest rate

ARM loans typically feature an adjustment "cap" which limits how much the interest rate can go up. However, the maximum payment should be factored into your budget. Rate caps can limit the size of interest rate changes both for periodic adjustments and for the life of the loan.

When finding out about ARM refinance options, be sure to ask the following questions:

  • Does the ARM you're considering include a rate cap?
  • How often does the rate change?
  • Can you convert your ARM to a fixed-rate payment? Some ARMs offer a conversion feature that allows you to convert to a fixed-rate loan at certain times during your loan term.
  • Is your ARM assumable?
  • Are there any penalties for paying off your loan early, also called a prepayment fee? Being able to prepay your ARM will allow you to refinance if rates go down.

ARM financial indices

Every ARM loan uses a money rate index to determine the loan rate for a set period. Lenders have no control over any of the money rate indices. You can track the performance of each index in The Wall Street Journal. The rate you pay is set at each adjustment period by adding the rate of the index plus your margin (which remains the same from period to period). Below are some common ARMs and the indices on which they're based.

Treasury-Indexed ARMs (T-Bills)

Tracks the weekly average yield of U.S. Treasury securities adjusted to a constant maturity of 6 months or 1 year. Per-adjustment caps and lifetime rate caps vary

London Interbank Offered Rate ARMs (LIBOR)

The LIBOR index tracks the rate international banks charge each other for large loans in the London interbank market. This ARM adjusts to the LIBOR annually based on the 1-year U.S. dollar-denominated deposits in the London market, as published in The Wall Street Journal. The 1-year LIBOR ARM has a lifetime cap of 5%.

Have more questions about ARMs?

Talk with an American Elite mortgage loan officer, who can help you decide if an ARM could be right for you.