ARMs

There are two basic types of home mortgage: fixed rate and adjustable rate. While fixed-rate mortgages are more popular, the adjustable-rate type can provide an interesting alternative to borrowers who are willing to assume more risk.

First, a basic definition: Adjustable Rate Mortgages (ARMs) have a fluctuating interest rate. This rate increases or decreases according to the market. (Fixed-Rate Mortgages (FRMs,) by contrast, have a locked-in rate.)

Most of the time, ARMs have an introductory, fixed-rate period. During this time, the interest rate of the home mortgage is quite low (usually lower than those of FRMs). This can be a huge incentive for borrowers who think they will sell the house after a short time.

After the introductory period, the interest rate changes every year or so. If market rates go up, ARM interest rates rise. If market rates lower, ARM interest rates also lower.

Like other home mortgages, the terms of an adjustable-rate mortgage vary widely. In general, you will have access to better terms if you have a high income and a good credit history. There are, however, basic features that most ARMs have. For instance, many will limit the amount your interest rate can rise during a given period. That way, if there is a market disaster and rates shoot up, you will have some protection.

Before you commit to an ARM, it is a good idea to check whether you will be able to switch to an FRM later in the life of the loan. That way, if your circumstances or market conditions change dramatically, you can obtain a more suitable mortgage.

One of the big reasons that ARMs are considered risky is because monthly payments are not predictable. If market rates are not favorable, a borrower could pay a higher monthly payment than expected.