There’s been a lot of talk lately about ARM (Adjustable Rate Mortgage) loans and the impact that they’ve had on the current economy. However, if you’re like many Americans, you may be wondering exactly what an ARM loan is. This article will cover the basics of ARM loans – what they are, how they work, and whether or not an ARM loan is right for you.

Adjusted rate mortgages (ARM loans) are loans that start out a very low interest rate. This rate is generally locked in for a certain period of time, after which it becomes adjustable – that is, subject to change. Most loans are structured so that the borrower gets 3-5 years at a very low interest rate, followed by an adjustable rate for the remainder of the mortgage. This adjustable rate varies with the current market trends, and can be quite a bit higher than the original introductory rate of the loan.

ARM loans come with both rate caps and rate ceilings. This means that the interest rate on the loan can only go so high, and it can only fall so low. This design is built in to help keep both the buyer and seller from losing large amounts of money due to fluctuating interest rates. There is also generally a dollar cap on monthly payment amounts. In theory, this is to protect the borrower from mortgage payments that change dramatically from year to year. However, the difference between the capped payment amount and the new amount after an interest increase is usually tacked on to the end of the loan. This may extend the loan longer than the borrower originally planned (or budgeted) for.

If you’re purchasing a house as a primary residence, and plan to live there for a long period of time, you’re probably better off with a traditionally structured, fixed rate loan. Although the rate offered may be higher than an ARM loan’s introductory rate, it will likely also be much lower than the adjustable rates that occur later in an ARM loan. You’ll also be locked in at a specific payment amount, making budgeting easy from year to year.

Adjustable rate mortgages often start out at a low introductory rate, which looks extremely appealing to home buyers. However, this rate can rise quickly over time. The loan is based on the idea that a person’s income rises over time – if this is not the case in your situation, you can quickly find yourself owing more on your mortgage than you can easily afford. While ARM loans come with an upper payment limit, the difference between the payment you owe and your payment cap is often tacked on to the end of the mortgage. This can mean that you owe much more money over time than you had originally planned.

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Filed under: Understanding ARMs

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