An adjustable rate mortgage (ARM) is a home loan for a fixed, longer term, but with an interest rate that adjusts (changes) during the life of the loan. ARMs became important when interest rates were escalating and banks no longer wanted to take the risk of lending at 4 or 5% and then seeing their costs of funds skyrocket to 10 or 12%.
For many years, interest rates remained fairly steady and banks had no problem setting a rate on a loan because their cost of funds remained fairly steady.
ARMs are for thirty years usually, with interest rates fluctuating in the course of those thirty years. What is the main worry to borrowers is how often the rate is adjusted. Unless, of course, the borrower knows he will be in the house for an extended period, in which case the longer term would be better since it will avoid any refinancing and the relevant charges.
Most of the time, the five year adjustment period is what is best for most borrowers. When the interest can be adjusted more often, the risk of spikes in the interest rate is greater. If your ARM is at 6% for five years, for instance, it will not increase, even if rates go up to 8%, then back down to 7%.
With an annually adjusted ARM, the homeowner would have had all of the increases in the interim. Most ARMS have an interest rate cap, however, to protect the borrower from runaway interest rates as well.
The length of time you think you will live in your home is the best gage for the adjustment period of your loan. Those who typically live in a house for a few years only care about the first rate of the loan. However, those who normally live in their homes for more extended periods will want the longer adjustment terms. Usually, a borrower will not be able to obtain an adjustment period longer than seven years.
You can get an ARM that is based on different interest rate instruments for example the LIBOR or Treasury Bills or Notes. Each of these has benefits and disadvantages, based on the length of time of the mortgage and the borrower’s concept of the future of interest rates and tolerance of fluctuating payments. Remember that if you have an ARM that adjusts frequently, your monthly payment will change often.
This is not an ideal situation for many people, who have to live on a fixed budget.
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Havens, Angel S. "Choose The ARM That Suits You Perfectly.." Choose The ARM That Suits You Perfectly.. 23 Jun. 2010. uberarticles.com. 3 Feb 2016 <http://uberarticles.com/business/choose-the-arm-that-suits-you-perfectly/>.
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