Home Buying 101: Adjustable Rate Mortgages

The Adjustable Rate Mortgage (ARM)

There are several ARM products out there that may fit your situation. These ARM products are usually a fixed rate mortgage for a certain number of years, and then can be adjusted each year after that. For instance, the common ARM products are a 5-year ARM, a 7-year ARM, and a 10-year ARM. If you think you will not be staying in your home for 10 years or longer, then the 10 year ARM might be the perfect solution. ARM products typically have a lower interest rate than the 30-year fixed products. For instance, a 10-year ARM may be 1% lower interest than a 30-year fixed. This savings can be substantial. Over the 10-year period, the savings on the interest can be $7000 or more.

The best situation for the ARM product is if you are just starting married life together and don’t have kids yet. When you have kids, you may want a larger house. If you are planning on having children within the 10-year period and think you may need a larger house in 8 years, then the ARM product is worth considering.

A typical 7/1-ARM product works like this. 7 years of the initial rate (3% as of July 2015), then it can adjust every year afterwards a maximum of 2% per year, and a lifetime maximum of 5% higher than the base rate. So here’s what a 7/1-ARM looks like:  3% (initial rate), 3%, 3%, 3%, 3%, 3%, 3%, max of 5% (year 8), max of 7%, max of 8% (year 10), max of 8% every year thereafter. Keep in mind that this is the “worst case scenario.”

Pros:

• Lower interest rate
• Save on the shorter term

Cons:

• Adjustable interest rate after the initial period