What is aPA Adjustable Rate Mortgage?

The PA Adjustable Rate Mortgage (ARM) definition is a 30 year mortgage that features a lower initial fixed interest rate period, typically of 3, 5, 7, or 10 years. After the fixed-rate period expires, the interest rate becomes adjustable for the remainder of the loan term. ARMs are often named by the length of time the interest rate remains fixed. Example: In a 5/1 ARM, the “5” stands for the five-year “introductory period,” during which the interest rate remains fixed. The “1” shows that the interest rate is subject to adjustment once per year after the introductory period and for the remainder of the loan term.

About the introductory period: The rate on this kind of loan tends to be lower during the introductory period, which could mean a lower starting monthly payment. However, when the introductory period ends, your rate will adjust depending on changes in the financial index to which your loan is associated.

Caps: ARMs have two kinds of rate caps. Adjustment caps limit how much your rate can go up or down in any single adjustment period, limiting how much your loan payment can change when it adjusts. Lifetime caps establish a maximum, and minimum, interest rate over the entire life of a loan. If you’re considering an ARM, find out what the caps would be and then run the numbers to see if you could still comfortably afford the monthly payments allowable under the rate caps.

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Advantage

Hybrid ARMs generally offer lower rates during the introductory fixed rate period than fixed-rate mortgages.

Considerations

After the introductory period’s fixed rate expires, the rate is subject to adjustment. The rate could increase at this point, which would also increase your payments. This can make paying your mortgage on time more difficult.

If you choose this kind of loan, be sure it includes an adjustment cap and/or lifetime interest cap. Keep in mind that many adjustment or lifetime caps would still result in payment shock, which is a term used to describe a significant increase in your monthly payment. For example, if you had a 5/1 ARM with a starting interest rate of 4.0% (and interest rates rose) and your rate increased by 2 percentage points in the first two adjustment periods, by year 7, your interest rate would be 8.0% — so your monthly payment would double from the starting monthly payment.