How Does an Adjustable Rate Mortgage Work?

There are plenty of options that homeowners have with financing when purchasing or refinancing a home. Home mortgages come in a wide variety of different ways to repay the loan. Interest rates will vary depending on what type of mortgage is being used for financing. For example, there are fixed mortgages, variable rate mortgages, adjustable mortgages, etc. All these mortgages have different ways of charging interest, which ultimately gives the lender the ability to reduce risks in certain markets and with certain buyers. An adjustable rate mortgage, also known as “ARM”, is a mortgage that has a rate that isn’t a fixed rate for the life of the loan.

In the beginning of an adjustable rate mortgage, the rate will be at a fixed rate, meaning the rate will not change regardless of what the market experiences. This fixed rate is only applied for a certain amount of time of the loan. It isn’t a permanent rate, and later into the mortgage contract the rate will change. After the period of the fixed rate of the mortgage, the mortgage’s rate will then move depending on the interest rate index. In other words, the interest rate on an adjustable rate mortgage will move in the direction that the interest rate index is associated with.

A lender or a broker that is in charge of issuing adjustable rate mortgages will give the borrower the rate that will be charged. This rate is the fixed rate that will be charged in the beginning of the mortgage. A fixed rate period of an adjustable mortgage usually last around 5 years. However, adjustable rate mortgages can shift anywhere from a single month, up to 10 years. Not only are adjustable rate mortgages associated with having a fixed rate period, they are also known to have more than one fixed rate period.

For example, an adjustable rate mortgage may have a rate that changes every 5 years. This means that within 5 years of a fixed rate period, the new rate can be either lower or higher. The new rate will then be locked at that rate for the duration of the next 5 years. The benefits of an adjustable rate are mostly experienced by those who are not planning on staying in the home longer than 5 years. For example, if a homeowner uses an adjustable rate mortgage, and then moves and sells the home before the interest rate goes up, they will effectively have avoided higher interest rates.

Because an adjustable rate mortgage is typically known for having a lower interest rate in the beginning of the mortgage, homeowners can save on interest as long as they move before interest rates go up. Homeowners who are planning on living in a home for quite a few years are advised to get a fixed rate mortgage. Homeowners who have a plan of avoiding higher interest rates on an adjustable mortgage by moving before rates go up are advised on getting an adjustable rate mortgage.

In times of high interest rates in the housing market, adjustable rate mortgages present an opportunity for homeowners to save on interest for a short period of time. However, the amount in which an adjustable rate mortgage can impose on the mortgage payments at a later date can be considered a financial hardship on some incomes, especially fixed incomes. Homeowners are advised to consider all the available options concerning mortgages in order to find what mortgage will best meet their needs. It’s extremely important to get familiar with how these mortgages work and how they can impact a family’s life, especially adjustable rate mortgages.