Adjustable Rate Mortgages

An Adjustable Rate Mortgage (ARM) has a variable interest rate component, which means the interest rate will change during the life of the loan. An ARM might be a tempting choice over a fixed rate mortgage because the starting interest rate is often lower than a Fixed Rate mortgage.

Before determining which type of home loan to choose, try to envision how long you will stay in this home before selling it. If you plan on moving up to a larger home after 5 years, you can consider a 5-year ARM. A 5-year ARM is fixed at the beginning interest rate for 5 years. After 5 years, your lender will be able to change your interest rate to match a benchmark rate (see the Index discussion later on in this article) plus a markup value, called a Margin. Often you’ll have your choice between different fixed rate periods – also common are 3-year ARMs and 7-year ARMs.

If you are considering a loan where the interest rate adjusts (an ARM, or Adjustable Rate Mortgage), make sure you ask these questions of your mortgage broker:

How long is the mortgage interest rate fixed?

A “3 year Fixed ARM” or a “3/1 ARM” usually means that the interest rate will be fixed for 3 years. After that the interest rates will adjust yearly according to the index it follows.

Let’s say you are comparing two adjustable rate mortgages on a $200,000 loan. One is an ARM where the interest rate is fixed for 1 year and may change every year after that, and the other loan is an ARM which is fixed for 5 years (often written as 5/1). Let’s say you think you’ll live in your home for the next 5 years. The following table shows payments for both loans: