How does an adjustable rate mortgage (ARM) work?

First-time and experienced buyers alike may be confused about which type of mortgage would be best for them. To determine which type of mortgage will suit your needs best, you should understand what an adjustable rate mortgage is and how it works. an adjustable rate mortgage, or ARM, is a mortgage in which the interest rate can fluctuate. Generally, an interest rate on an adjustable rate mortgage remains fixed for a period of time, after which the lender may raise or lower the rate. Typically, an interest rate increases or decreases according to the national average home loan interest rates. For example, if rates are low, your interest rate may remain constant or even decrease; however, if rates increase, it is likely that your interest rate will increase as well.

benefits of an adjustable rate mortgage:

  • The initial interest rate on an ARM is usually lower than the initial interest rate on a fixed rate mortgage. Lenders offer low initial interest rates on ARMs for the first two or three years to attract buyers to this type of mortgage. Eventually, lenders can increase interest rates to generate a greater profit for themselves over the life of the loan.
  • an ARM can allow you to qualify for a greater loan because you will initially pay a lower interest rate.
  • If interest rates decrease over time, your payments may be lower, too.
  • If you plan to own your home for less than five years, you could pay a low initial interest rate and then sell your home before interest rates increase.

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ARMs are a good option for families who plan to own their home for only a few years. an ARM allows you to lock in a low initial rate. as rates increase, you may sell your home and pay off the mortgage.

Some disadvantages of adjustable rate mortgages are:

  • Monthly payments can vary, which can make budgeting and financial planning difficult.
  • Lenders may increase interest rates at their discretion, and they are not required to lower interest rates when national rates decrease.
  • Rates often increase once the short, initial period is over, which causes monthly payments to increase, too.

Because an ARM allows mortgage companies to raise rates, most companies probably will so that they can increase their profits. However, there is a cap, or limit, to how high mortgage companies can increase interest rates on an adjustable rate mortgage. Usually, the cap is a certain percentage per year. If you chose to get an ARM through the VA Loan program to buy your home, check the cap interest rate to ensure that you will be able to make the payments in the future. Learn more about ARM's vs fixed rate mortgages.

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