It may be important for you to have a lower initial interest rate, and subsequently a lower monthly payment, in order to qualify for the house of your dreams. If this that's the case, an Adjustable-Rate Mortgage might be best for you.
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An Adjustable-Rate Mortgage (ARM) comes in many varieties. An ARM is a type of loan with an adjustable interest rate, typically 1, 3, 5, or 7 years. ARM interest rates tend to be lower than some of the longer fixed-rate loans. Once your adjustable-rate term ends, your interest rate will increase each year.
Most adjustable-rate loan programs have a “cap” that protects you from your monthly mortgage payment going up too much at once. There may be a cap on how much your interest rate can go up in one loan period. For example, you may have a cap that will not allow your rate to go up more than two percent per year, even if the underlying index goes up more than two percent in that same year.
An adjustable–rate mortgage (ARM) is a type of mortgage in which the interest rate applied on the outstanding balance varies throughout the life of the loan. With an adjustable–rate mortgage, the initial interest rate is fixed for a period of time, after which it resets periodically, often every year or even monthly.. – Investopedia
As part of your loan agreement, you may instead have a payment cap that caps the amount of increase in your monthly payment. Most Adjustable-Rate Mortgages also have lifetime caps, which defines the amount your interest rate can increase to over the life of your loan. Adjustable Rate Mortgages often have their lowest, most attractive rates at the beginning of the loan, and can guarantee that rate for anywhere from a month to seven years.
Loans that are called “3/1 ARMs” or “5/1 ARMs”mean that the introductory rate is set for three or five years, and then adjusts according to an index every year thereafter, for the life of the loan. Loans like this are typically used by people who anticipate selling the house within three or five years, depending on how long the lower rate will be in effect.
You might choose an Adjustable Rate Mortgage to take advantage of a lower introductory rate and count on either moving, refinancing again, or simply absorbing the higher rate after the introductory rate goes up. ARMs come with the risk of your rate going up, but they also have the advantage of lower introductory rates.