Unlike fixed rate home loans which have fixed rates for fixed terms, ARMs have changing rates over fixed terms. As interest rates started skyrocketing in the seventies, lenders decide to protect themselves against this risk by setting interest rates more often.
When interest rates were steady for years at a time, traditional fixed rate mortgages worked; when interest rates became volatile, banks bagan protecting themselves with ARMs.
ARMs are for thirty years typically, with interest rates changing during those thirty years. What is the main worry to borrowers is how frequently the rate is reset. If a homeowner plans to live in his home for a considerable time, he should try to geta fixed rate loan since paying off an ARM means new closing costs, etc.
Most of the time, the five year adjustment period is what is best for most borrowers. If you pick an ARM that changes the rate more frequently, you take a big chance on being hit by temporary spikes in the interest rate. For example, if your mortgage rate is 6%, it will stay at 6% for five years, even if market rates increase to 8% over these five years.
With an annually adjusted ARM, the homeowner would have had all of the increases in the interim. But you may be protected against rapidly increasing interest rates with a cap agreement.
You should also take into account the number of years you plan on being in the home. If you plan on being in a home for only four or five years, the initial rate of an ARM is the only rate that is of concern to you. If you think you will be in a home for six or seven years, try to get a seven year adjustment. Typically, a borrower will not be able to obtain an adjustment period greater than seven years.
You also have to understand which base rate is being used for the rate adjustment: government bonds, the LIBOR, CDs or others. There are advantages and disadvantages about each of these, but they depend on how long you plan on holding the loan, and how you think interest rates will behave. Keep in mind that any ARM with a frequent adjustment period will change your monthly payment frequently.
This is not an ideal situation for many homeowners, who have to live on a fixed budget.
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BlancheG.Gatlin, BlancheG.Gatlin "Which ARM Is The Right One For You?." Which ARM Is The Right One For You?. 26 Jun. 2010. uberarticles.com. 13 Oct 2014 <http://uberarticles.com/finance/which-arm-is-the-right-one-for-you/>.
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