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Adjustable Rate Mortgage Loans

Adjustable Rate Mortgages (ARM) offer lower interest rates at the beginning of a loan with the chance that rates could be raised later on. This risk is taken by both the lender and the borrower.

There are four basic principles of an ARM loan:

• The initial interest rate is fixed 1-3 percentage points lower than fixed rate mortgages.
• After the initial period has elapsed, an adjustment interval takes effect and the rate is modified in keeping with prevalent rates.
• An index against which lenders can measure the difference between the interest earned on the loan and what would be earned in actuality in other investments is used to adjust rates.
• The component added by the lender to the index, is usually 1.5-2.5 percent.

ARM, is ideal if you are certain about rising income expectations and short-term home ownership. Safeguards like interest rate caps limit the amount of interest rate that can be applied to the payment during adjustment. Normally this cap would be about a 2% point cap over the life of the loan.

You can opt to buy a property with a higher value and still pay a lower initial monthly payment with ARM. ARM lends you buying power. If you know for certain that you will reside in the house you are buying for 5-7 years at the most, then ARM is the mortgage that will save you money. If you are prepared to take risks then ARM offers the greatest possible savings especially if the rate stays steady or declines over the years.

There are no certainties with ARM, it is a calculated risk. However if at the end of five years your plans change and you are about to continue in the same home for another 10 years then it is prudent for you to switch from ARM to a fixed rate mortgage.