Adjustable Rate Mortgages

Adjustable Rate Mortgages

ARMs - adjustable rate mortgages - feature a periodically changing interest rate during the life of the loan, usually in relation to a financial index, such as the prime rate. The major benefit of these loans is they generally start with a lower initial interest rate. Lenders generally use an introductory rate (an artificially low rate) to make this type of loan more attractive to potential borrowers. This can mean significant cost savings during the first years of the mortgage. And an ARM could be less expensive over a long period if interest rates stay flat or decrease. In addition, you may also qualify for a larger loan, as some lenders may decide your ability to pay based on your current income and the first year’s payments alone.

But be careful. Remember that you're getting a lower rate with an adjustable mortgage in exchange for taking more risk. Sometimes the initial rate is only good for the first year, then adjusted - higher or lower - on a regular schedule, which means your payments can go up or down. However, some adjustable rate mortgages put a cap on the interest rate increase from one period to the next. And virtually all types of adjustable rate mortgages put a ceiling on rate increases over the life of the loan.

Ask yourself a few questions to determine if an adjustable rate mortgage is the right loan for you:

1. How long do I plan to own this home? (If it's a short-term investment, any increase in interest rates will not impact you.)
2. What other financial obligations do I have, and do I expect an increase in monthly bills (such as new car loan)?
3. If interest rates rise, will my income go up enough to cover higher mortgage payments?

Keep in mind if mortgage rates are low, and you plan to stay in the house for more than 2 or 3 years, a 15, 20 or 30-year fixed rate mortgage may be a better option, locking in a favorable interest rate for the life of the loan. Adjustable rate mortgages carry risks in periods of rising interest rates, but they can be cheaper over a longer term if interest rates decline.

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