Personal Finance

Learn about adjustable-rate mortgages or ARMs

A mortgage is a loan which is obtained from a bank or finance company for buying a house. When you are looking to finance the purchase of a new home loan, you have mainly two options to refund the amount – adjustable-rate mortgages or fixed-rate mortgages.

Adjustable-rate mortgages (ARM mortgages) are one of the main types of mortgages available in today’s money market. Adjustable-rate mortgages, often referred as variable rate mortgages, allow its interest rate to change (increase or decrease) at regular intervals according to the prevailing interest rates in the market. In other adjustable-rate mortgages are those loans which are secured on a property (mainly home) whose interest rate as hence monthly repayment will change according to the change in the interest rates in the money market.

In simple terms adjustable-rate mortgages are opposite of fixed rate mortgages. This is because in fixed-rate mortgages the interest rate and hence monthly payment will remain fixed for the entire loan period.

Adjustable-rate mortgages features lower initial interest rates when compared to fixed-rate mortgages. And one of the major advantages of having an adjustable-rate mortgage is that if the interest rate remains steady or continues dropping you can save a substantial amount of money. Knowing this feature, most of the borrowers usually prefer adjustable-rate mortgages as their first choice.

But before choosing adjustable-rate mortgages it is better from your part to consider how much will be the maximum amount in your monthly payment if the interest rate rises. Also, as the loan amounts are usually provided by considering the ratio of one’s current monthly income to the cost of the loan’s first year of payments, an adjustable-rate mortgage would sometimes be a larger amount when compared with fixed rate mortgages.

Let us look at some of the advantages of using an adjustable-rate mortgage:

  1. The initial payments will be low owing to lower beginning interest rate.
  2. The borrower’s can opt for higher loan amount owing to the lower beginning interest rates.
  3. The interest payments will be less if the interest rate decreases over time.
  4. Interest rate caps limit the highest interest payment offered for the mortgage.

Some disadvantages of adjustable-rate mortgage are:

  1. There will not be any idea of what will be your future monthly payment.
  2. The initial lower interest rate and monthly payments of the mortgage are only temporary and will be applicable for the first adjustment period. In most cases it is seen that the interest rate may increase after the first adjustment period.
  3. If the interest rate increases over time your interest payments will be high.

Adjustable-rate mortgages are well suited for those people who are ready to take a risk based on the guess that the interest rate of their mortgage will remain stable or go down. For example, if the interest was 5% and the high cap was 12% and the current interest rate is 20%. One need not bother, as he still needs to pay only 12%. Hence it is a better idea to consult with a mortgage specialist who can suggest whether adjustable-rate mortgages are the right one for you.