Home Loans - Adjustable Rate Mortgages

Should I choose an Adjustable Rate Mortgage? Adjustable Rate Mortgages (often called ARMs) typically last for 15 or 30 years, just like fixed rate mortgages. But during those years, the interest rate on the loan may go up or down within certain limits. Monthly payments increase or decrease, typically at a set time each year.

An ARM may suit you if you:

• Are comfortable with the possibility of monthly payment adjustments (especially increases in monthly payments). There are interest rate caps on how much your rate and, therefore, payments may change in each adjustment period, and over the lifetime of the loan. If you are interested in this type of loan program, ask for details about these caps.

• Foresee your income increasing — You believe that lower monthly payments is a big consideration today, but your career prospects are very bright. Your income should increase to accommodate the likely increase in monthly payments in future years.

• Plan to stay in your home or loan for less than 5 years (or before the first adjustment period begins) — You believe you'll sell or refinance your home before the interest rate on an ARM can go up.

With an ARM come several benefits that can make your mortgage more affordable. The initial interest rate on these loans is typically lower than a fixed rate mortgage. That means starting monthly payments are also lower.

The lower monthly payments can make it easier to get approved for an ARM. And, typically you can borrow higher amounts. This may be good news if you are:

• Buying a home for the first time

• Moving up to a more expensive home

• Refinancing

• Looking for a way to consolidate debt

• Planning on making an investment for which you need cash now

However, the lower rates and lower payments can change. Each ARM includes a provision that says your lender can adjust the rate at a specific time, during the "adjustment period." Adjustment periods for ARM loans can range from 1 month to several years.

As a general rule, the shorter the adjustment period, the lower the initial interest rate offered — a 1-month ARM often comes with a lower initial interest rate than does a 6-month or 1-year ARM.

How much change should you expect? As interest rates in the general economy change, ARM rate changes, too. Each ARM is tied to a specific index. To determine the amount of change, lenders base your new rate on the interest rate index (which is published and not controlled by the lender), plus a margin.

Examples of indices include:

• Interest rates set by the government — Treasury Bills and the Federal Home Loan Bank.

• Interest rates banks charge each other — such as LIBOR, London Inter-Bank Offering Rate.

Interest rate changes are great news if interest rates go down. But what if interest rates rise — or rise a lot? The majority of ARMs have rate caps for your protection.

Two rate caps to look for in an ARM:

• Adjustment Period Cap — limits the amount your rate can change at each adjustment period. The most common caps are between 1% and 2%.

• Lifetime Cap — limits the amount your rate can change from the initial rate through the life of the loan. The most common caps are between 6% and 7% higher than the initial interest rate.

ARMs without a cap are not a good idea. If your lender offers no rate cap, look for another lender.