If you are looking to buy a home, you may have come across the term ARM loan. Adjustable rate mortgages are one of the most popular types of home loans available today, so it’s important to understand what they are and how they work before making any decisions.
In this article, we will explore adjustable-rate mortgages in detail. We will also discuss how ARM mortgage loans work, their advantages and disadvantages, and more.
An adjustable-rate mortgage, or ARM loan, is a type of home loan where the interest rates may adjust periodically. This can cause your monthly payments to change as well. Some people prefer this type of loan because it offers lower initial interest rates than a fixed-rate mortgage.
What Exactly Is an ARM Loan?
So, what is an ARM loan? The definition of an ARM loan is that it’s a type of home loan where the interest rate may adjust or “float” over time. Meaning, that the initial interest rate is usually lower than that of a fixed-rate mortgage, but it may increase periodically throughout the life of the loan.
ARM loans are usually used by borrowers who plan to own their home for only a few years, as they offer monthly payments that can be lower than those of a 30-year fixed-rate mortgage in the early years of the loan.
The most common type of ARM is the 5/1 ARM, which has a fixed interest rate for the first five years and then adjusts annually thereafter. Other popular ARMs include the 3/1, 7/1, and 10/1.
How Do ARM Loans Work?
But how does an ARM loan work? An adjustable-rate mortgage works like any other home loan, except that the interest rate may adjust periodically. The most common time frames for adjustment are every 1, 3, or 5 years. The frequency of adjustment depends on the terms of your loan agreement.
Your monthly payment will be based on the interest rate at the time of adjustment. If rates go up, your payment will increase. But if rates go down, your payment will decrease. Some ARMs allow you to make voluntary prepayments which can help offset any future increases in your monthly payment.
Different Types of ARM Loans
In case you are considering an adjustable-rate mortgage, it’s important to understand the different types of ARM loans available. Here are some common types of ARM loans:
- Standard ARM
- Interest-only ARM
- Negative amortization ARM
- Balloon payment ARM
Fixed vs. Variable Arm Loan: Which One Is Better?
The biggest difference between a fixed rate vs. a variable rate loan is the interest rate risk. With a fixed-rate loan, your interest rate is locked in for the life of the loan. This means that no matter how high rates go in the future, you will always have the same monthly payment.
On the other hand, with a variable-rate loan, your interest rate can change at any time. This means that your monthly payment could go up or down depending on market conditions.
So. which type of loan is better? It depends on your personal circumstances and financial goals. If you are someone who likes to know exactly what their monthly payments will be, then a fixed-rate loan is probably a better option for you.
However, if you are comfortable with some uncertainty and are willing to take on more risk in exchange for the potential for lower payments, then an ARM loan could be a better choice.
Pros and Cons of ARM Loans
As much as ARM loans can be very beneficial to borrowers, there are both pros and cons you should be aware of. It’s very important to weigh them out before making a decision.
Pros:
- Has lower interest rates
- Possibility to pay principal every month
- Rates can go down
Cons:
- Rates can rise
- Monthly payments can fluctuate
- Caps can cause negative amortization
Pros
First, ARMs usually offer lower interest rates than fixed-rate mortgages, at least at the start of your loan. This can save you money on your monthly payments and help you qualify for a larger loan. Additionally, if interest rates rise after you have locked in a low rate with an ARM, you will still be paying less than if you had chosen a fixed-rate mortgage.
Another pro of an ARM is that it can offer more flexible repayment terms than a fixed-rate mortgage. For example, some ARMs allow for negative amortization, which means that your monthly payments could be less than the amount of interest accruing on the loan. This could give you some breathing room if you hit a financial rough patch.
Cons
One of the biggest potential drawbacks of an ARM loan is that your interest rate could increase over time. This means that your monthly payments could go up, and you could end up paying more in interest over the life of the loan.
Also, if interest rates go up and you can’t afford your monthly payments, you may not be able to refinance into a fixed-rate loan. This could leave you stuck in a situation where you are struggling to make ends meet.
And if you can’t make your monthly payments, your home could ultimately be foreclosed on. This would result in you losing your home and potentially damaging your credit score.
Is an ARM Loan Right for You?
An adjustable-rate mortgage, or ARM loan, is a home loan with an interest rate that can change over time. In most cases, the interest rate on an ARM loan is lower than the interest rate on a fixed-rate mortgage for the first few years of the loan. After that, the interest rate on an ARM loan may go up or down depending on changes in the market.
So, is an ARM loan right for you? That depends on a few things. First, do you plan to own your home for a short period of time? If so, an ARM loan could save you money on interest over the life of your loan.
Second, are you comfortable with the idea of your interest rate going up or down in the future? In case the answer is yes, an ARM loan could make sense for you. Keep in mind that if rates go up, your monthly payments will also go up.
Third, are you sure you can afford the monthly payments if rates go up? By any means, if you are not, an ARM loan might not be right for you. Be sure to talk to a lender about what your monthly payments would be if rates increased before you decide to get an ARM loan.
Bottom Line
ARM loans provide many benefits that borrowers should use to their advantage. But with that said, you should also weigh out the downsides as well before getting one.
With that in mind, we have made this article that can help you understand ARM loans better and see if they are good for you or not. Ultimately, the decision lies on you, but make sure to think about it thoroughly. Always consult with an expert and shop around and compare before putting your name on the dotted line.
