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Adjustable Rate Mortgages

With an adjustable rate mortgage (ARM), the interest rate is fixed for a certain number of years, and then it goes up or down periodically based on a benchmark economic index. With every rate adjustment, the mortgage payment will change. The initial rate of an ARM is usually lower than the rate of a fixed rate mortgage.

The amount of time between rate adjustments is called the adjustment period. Many ARMs have a one-year adjustment period, meaning that the interest rate will adjust every year. Because rate adjustments can be unpredictable, most ARM programs offer a rate cap that limits the amount the interest rate can increase each year or over the term of the loan. The term for most ARMs is 30 years.

Advantages of an ARM:

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After the initial fixed rate period, monthly payments could decrease if interest rates go down.
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It may be a good choice for a homebuyer who plans to sell a new home after a few years.
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It may be suitable for a homebuyer planning to refinance a new home within five to seven years.
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It may be appropriate for a homebuyer who likes the initial payment stability but can afford later adjustments in interest.

Disadvantages of an ARM:

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After the initial fixed rate period, monthly payments could increase if interest rates go up.
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It may not be the optimal choice for homebuyers on fixed incomes.
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It may not be the best choice for homebuyers who plan to keep their homes or properties for longer than the initial fixed rate period.

Types of Adjustable Rate Mortgages

An ARM is often written as a pair of numbers – for instance, “3/1 ARM”, “5/1 ARM”, “7/1 ARM” or “10/1 ARM.” The first number indicates the number of years the interest rate will remain fixed. The second number indicates the adjustment period of the loan, or how many years it will be before the interest rate adjusts.

3/1 adjustable rate mortgage

With a 3/1 adjustable rate mortgage, you have three years at the initial fixed rate, then the rate adjusts every year for the remaining life of the loan. This could be a good choice if you expect to move or refinance in a relatively short period of time. But a much shorter fixed-rate period means your interest rate (and therefore monthly payments) may begin to fluctuate after three years.

A 5/1 adjustable rate mortgage means the initial rate remains fixed for the first five years of repayment, then adjusts every year thereafter. Remember that your rate and monthly payments may go up after only five years, so this choice is best if you're expecting to sell or refinance the property within that period.

A 7/1 adjustable rate mortgage offers an initial rate that is fixed for the first seven years of repayment. After seven years, the rate adjusts every year thereafter for the remaining life of the loan.

With a 10/1 adjustable rate mortgage, the initial rate of the loan is fixed for the first ten years of repayment. After 10 years, the rate adjusts every year thereafter for the remaining life of the loan. The loan is amortized over 30 years, so you'll enjoy the stability of a 30-year mortgage at a lower price than a fixed-rate mortgage of the same term. But an ARM is likely not the best choice if you're planning on owning the same property for more than 10 years.

Adjustable-Rate Mortgage Disclosures

Type of Product Adjustable Rate Disclosures
3/1 Year P&I ARMs DownloadDownload PDF
5/1 Year P&I ARMs DownloadDownload PDF
7/1 Year P&I ARMs DownloadDownload PDF
10/1 Year P&I ARMs DownloadDownload PDF

To learn more, review the consumer handbook on adjustable rate mortgages.

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