What is an Adjustable Rate Mortgage (ARM)

An adjustable-rate mortgage, or ARM, is a home loan with an interest rate that can change periodically. This means that the monthly payments can go up or down.  ARMs may start with lower monthly payments than fixed-rate mortgages, but keep in mind that your payment can go up even if interest rates don’t go up.  With an ARM, the interest rate changes periodically, usually in relation to an index, and payments may go up or down accordingly.

• Payments can change
• In some cases negative amortization can take place

Lenders generally charge lower initial interest rates for ARMs than for fixed-rate mortgages. At first, this makes the ARM easier on your pocketbook than would be a fixed-rate mortgage for the same loan amount. Moreover, your ARM could be less expensive over a long period than a fixed-rate mortgage—for example, if interest rates remain steady or move lower.

Hybrid ARMs

Hybrid ARMs often are advertised as 3/1 or 5/1 ARMs—you might also see ads for 7/1 or 10/1 ARMs. These loans are a mix— or a hybrid—of a fixed-rate period and an adjustable-rate period. The interest rate is fixed for the first few years of these loans—for example, for 5 years in a 5/1 ARM

Interest Only ARMs

An interest-only (I-O) ARM payment plan allows you to pay only the interest for a specifi ed number of years, typically for 3 to 10 years. This allows you to have smaller monthly payments for a period. Aft er that, your monthly payment will increase—even if interest rates stay the same—because you must start paying back the principal as well as the interest each month.

Payment-Option ARMs

A payment-option ARM is an adjustable-rate mortgage that allows you to choose among several payment options each month. The options typically include the following:

• Traditional Payment (principal and interest)
• Interest Only Payment
• Minimum Payment (may be less than monthly interest)

 

Pros	Cons
Generally, the initial interest rate is lower than on a comparable fixed-rate mortgage. After the fixed-rate period ends, the interest rate can go lower, so monthly payments can fall, too	After the fixed-rate period ends, the interest rate can rise, so monthly payments can go up, too. Interest rates are unpredictable, so you cannot predict what your payments will be in the future.