Is an Adjustable Rate Mortgage Right for You?

If you are considering purchasing a home or refinancing your existing mortgage and you only plan on being in your property for less than 7 to 10 years, then it may make sense to consider an adjustable rate mortgage. Often referred to as ARMs, adjustable rate mortgages have initial rates which are set for a specific number of years before then adjusting up or down based upon the movements of an interest rate index which the loan are tied too. Some commonly used indexes which ARMs use include the 1 Year Treasury Constant Maturity Rate and the 1 Year LIBOR (London Interbank Offered Rate).

When shopping for ARMs, consumers should make sure that they have a firm understanding of the loans' margins, their associated indexes, the adjustable intervals, and the caps for the adjustments. Consumers should also be aware that the first adjustment may be potentially greater than that of future adjustments.

For example:

A mortgage loan officer quotes a 7/1 LIBOR ARM with a start rate of 4.500% and a 2.5% margin and a initial rate cap of 5% and then annual rate caps of 2% for every year thereafter. In this scenario the intro rate would be set at 4.500% for the first seven years of the loan. On the 85th month, the loan would adjust by adding the loan's margin (2.5%) to the current index rate (say 2.250%). The result would be the "fully indexed rate" of 4.750%. In this scenario, a person would only see their rate slightly increase on the first adjustment. Depending upon the current index rate, the loan may be limited in its first adjustment by the 5% cap limit.

Should You Consider an Adjustable Rate Mortgage?

Adjustable rate mortgages do carry a higher degree of risk and it is really up to consumers to determine whether the rewards outweigh the potential downside. The first step is to analyze how much lower current ARM rates are than fixed rate mortgage rates and determine how much savings there may be in the introductory rate period. Unless the adjustable rates and savings are very attractive, the borrower may want to play it safe with a fixed rate home loan product. ARM borrowers should also feel confident in their ability to refinance before their loan's first adjustment and that the real estate values in their community are in a stable or appreciating environment. The last thing a borrower wants is to be upside down on their mortgage and stuck in an ARM without the ability to refinance.

There are a variety of ARM products to choose from in today's marketplace including both conforming and non-conforming loans (aka jumbo loans) as well as low money down FHA loan solutions. No matter which type of mortgage program you choose, always be sure to fully understand the ins and outs of a product before signing on the dotted line.