You may think of arms as tools for throwing a baseball, hugging your child and driving your car. In the mortgage and lending industry, ARMs stand for Adjustable-Rate Mortgages.
The total amount of your mortgage is the amount you borrowed plus the pre-agreed interest. Unlike a Fixed-Rate Mortgage where the interest is set for the life of your loan, the interest on an ARM varies over time. This means your monthly payment can rise or fall.
How is Your Monthly Payment Determined?
The formula used to determine your monthly payment will be predefined in your loan agreement. Typically, it is made up of two parts: the index and the margin.
The index is a specific measure of interest rates in the market. Lenders can base your ARM on a variety of indexes. The index which will be used for your specific loan should be predetermined in your mortgage agreement. This is the piece which causes your loan payment to fluctuate.
The margin is an additional interest rate applied to your loan. It is preset by your lender and typically stays the same throughout the lifespan of your loan.
In most cases, ARMs have an initial fixed-rate period during which time your monthly payment does not change. This is often called the fixed-rate honeymoon.
The length of this fixed-rate period varies from mortgage to mortgage. Sometimes it is as short as one month, but it could be as long as 10 years. At the end of this initial honeymoon, your monthly payment will typically go up.
How long is an ARM?
Like all loans, the length of your ARM is determined by the terms of your loan. Traditionally, the lifespan of an ARM is 30, 20 or 15 years. This lifespan includes the fixed-rate honeymoon phase.
Advantage: Typically, ARMs have lower initial rates, allowing borrowers to purchase a more expensive home or have a lower initial payment.
Disadvantage: Unpredictable monthly payments can make budgeting difficult.
Have questions about adjustable-rate mortgages? Curious if an ARM is right for you? Talk to Desiree today.