What Is an Adjustable Rate Mortgage?

Unless you’re buying a home outright with all cash — and if you are, good for you! — you’ll fund some amount of your purchase with a mortgage loan. The classic mortgage that most people are familiar with is the 30-year fixed loan, where the loan amount and interest are amortized over a 30-year period. However, and particularly when rates are on the rise, it’s worth knowing about other kinds of mortgages.

An Adjustable Rate Mortgage (ARM) is pretty much what it sounds like. Typically, there is a period of time where the rate is fixed, and after that term the rate becomes adjustable. The most common types are 3/1, 5/1, 7/1 and 10/1 ARM loans. In each case, it means that the rate is fixed for the first 3, 5, 7, or 10 years respectively, and then the rate goes adjustable for the remainder of the 30 year term of the mortgage.

So why would you opt for this instead of a good old normal 30-year fixed? Often, the rates on ARMs are lower than on a 30-year fixed. So in times where rates are high or climbing, you may be able to lock in a lower rate, and hedge your bets on being able to refinance at a later date when the rates may have gone down.

Case in point: When dpaul and Sean bought their first home in 2004, rates were somewhat high, about 8% for a 30-year fixed. But working with our amazing finance team, and them knowing that the equity on the property was likely to grow in a short time, they were able to lock in on a shorter-term ARM at 6.75%. By the time the fixed term was about to expire, rates had decreased, and they were able to refinance on a 30-year fixed at a preferable rate.

Of course you can neither predict nor control where rates will go, but you still have some power with an ARM by setting caps to protect against these increases. A periodic cap limits how much your rate can adjust at specified adjustment dates. A lifetime cap limits how much your rate can increase over the life of your loan. A payment cap limits how much your monthly payment can increase with each adjustment.

Getting ready to jump into the market? Contact us so we can connect you to our financing team, who can help you find the best way to achieve your goals.