Adjustable Rate Mortgage

Adjustable Rate Mortgage

Here is another type of mortgage you should be familiar with as it might be the right one for you. An Adjustable Rate Mortgage, also know as an ARM, is a mortgage loan with an interest rate that is reviewed at intervals and changes over the life of the said loan based upon changes in the current interest rates, most of the times, the prime interest rate. This rate adjustment affects both the monthly payment as well as the interest rate of the loan.  If you have an adjustable rate mortgage and the interest rate drops, then you benefit from the lower mortgage rate instead of being locked into the higher mortgage rate as you would be with a fixed mortgage. 

Besides the fact that it can be very beneficial for you, especially if the rate drops, an ARM mortgage usually begins with a lower interest rate than a fixed rate mortgage.  As a consequence, you will have lower monthly payments which, in turn, may also allow for the borrower to get a larger mortgage.  In case a fixed rate becomes challenging to get, an ARM may be beneficial if the rates are constantly fluctuating. 

On the other hand, the risk is that if interest rates rise, then you will have to assume the rise in monthly payments as well. It works both ways.  The other part that is important to understand is that adjustments can come without much notice, and as often as eight times per year. 

Let’s consider the following example: you can obtain an adjustable rate mortgage of $100,000 with a prime rate of 3% plus 5% with a maximum of 10%. This means that the borrower’s interest rate is 8% (5% + 3%) and the monthly payment would be $733.77. However, let’s say the prime rate increases to 4%, then the mortgage’s interest rate becomes 9% (5% + 4%), and the monthly payment will be $804.63. 

Adjustable rate mortgages are beneficial if you can withstand fluctuation in monthly payments but want to take advantage of lower rates.