Definition

An adjustable-rate mortgage (ARM) is a home loan with an interest rate that can change periodically based on an index. This means your monthly payments can go up or down over time.

Key Features

• Initial Fixed Period: Usually lower interest rate for an initial period (e.g., 5 years).
• Adjustments: Interest rate adjusts periodically after the fixed period.
• Caps: Limits on how much the interest rate can increase per adjustment period and over the life of the loan.

Pros and Cons

• Pros: Lower initial rates, potential savings if rates decrease.
• Cons: Uncertainty of future payments, potential for higher costs if rates increase.

Comparison

ARMs can be a good option if you plan to sell or refinance before the adjustment period begins.

Suitability

Ideal for borrowers who expect to move or refinance before the rate adjusts.

Calculation

Monthly payments vary based on the current index rate plus a margin.

Examples

A 5/1 ARM with an initial rate of 3% for the first 5 years, then adjusting annually based on a specified indexARMs can be beneficial in a declining interest rate environment.

Best Practices

Understand the terms, including the index and margin, and have a strategy for rate increases.