Adjustable-Rate Mortgages
Adjustable-rate mortgages (ARMs) have grown in popularity recently. Find out more about these loans to determine if they are right for you.
Background
ARMs differ from fixed-rate mortgages in that they have interest rates and monthly payments that fluctuate as market interest rates change. A typical ARM will have a fixed-rate period where your interest rate remains constant, followed by an adjustable-rate period during which your interest rate will adjust at certain intervals. Some consumers find ARMs appealing because they offer very low mortgage quotes initially. These low rates are presumably offered to offset the risk lenders are taking of paying much higher interest rates down the road.
Types of ARMs
You can get low mortgage quotes on a variety of adjustable-rate loans. Some loans have an initial fixed-rate period as short as one month or as long as ten years. Today, the type of ARM on which most consumers get low mortgage quotes is the 5/1 ARM. This means that the initial fixed-rate period lasts five years, after which the interest rate adjusts every year. ARMs that mix a long fixed-rate period with an even longer adjustable-rate period are called hybrid ARMs. You can also find low mortgage quotes on 10/1, 7/1, and 3/1 hybrid ARMs. You should also consider the caps on your ARM when shopping for low mortgage quotes. ARMs usually come with annual, lifetime, and payment caps that limit the amount by which your interest rates/payments can rise in a certain amount of time.
What Happens When Rates Adjust
If you get low mortgage quotes on ARMs, you have to keep in mind that the fixed-rate honeymoon period doesn't last forever. Sooner or later, you will be stuck with fluctuating interest rates that are tied to an index value, to which the lender adds a certain margin. Every time your ARM adjusts, the process repeats. Most of the ARMs you get low mortgage quotes on will be tied to one of the following indexes:
- Maturity yield on the one-year T-bill. This is the yield that debt securities issued by the U.S. Treasury are paying
- Costs of Funds Index (COFI). The interest banks in the western United States are paying on the money they hold.
- London Interbank Offered Rate (LIBOR). The going rate that most international banks charge one another on large loans.
If you still have questions that need to be answered, you can see if they were answered in our frequently asked questions.
