Adjustable-rate Mortgage (ARM)

An Adjustable-rate Mortgage (ARM) is a type of home loan where the interest rate can change periodically, usually in relation to an index, making monthly payments fluctuate over time.

Example #1

For example, if you have a 5/1 ARM, your initial interest rate is fixed for the first five years and then adjusts annually. If interest rates go up, your payments may increase.

Example #2

Alternatively, a 7/1 ARM means your rate is fixed for the first seven years before adjusting annually.

Misuse

Misusing an ARM could involve underestimating potential payment increases. For instance, if a borrower only considers the low initial rate and doesn't plan for potential future rate adjustments, they might face financial strain when the payments rise. It's crucial to educate consumers about the risks associated with ARMs and ensure they understand the potential payment adjustments.

Benefits

One benefit of an ARM is that during the initial fixed period, the interest rate is often lower than that of a fixed-rate mortgage, resulting in lower initial monthly payments. This can be advantageous for individuals who plan to sell or refinance before the first adjustment period.

Conclusion

Adjustable-rate Mortgages offer flexibility with initial lower rates but come with the risk of future payment increases. Consumers should carefully weigh the benefits and risks, considering their financial goals and plans for homeownership.

Related Terms

MortgageInterest RateFixed-rate MortgageRefinance