What Are Adjustable Rate Mortgages? | Journey Home Lending

When you’re considering home loans, one of the first decisions you’ll need to make is whether you want a fixed- or adjustable-rate mortgage. It’s important to understand the options and what advantages and disadvantages each could provide for your situation.

While fixed rate loans are easier to understand—after all, they stay at the same rate as long as you have them—adjustable rate mortgages (ARM) can be a bit confusing. So, here’s a little explainer that could help and some of the pluses and minuses you may want to consider.

What Is an Adjustable Rate Mortgage?

As the name makes clear, the interest rate you pay on this type of mortgage changes during the course of your repayment. Also called variable-rate mortgages, these offer a fixed rate for the early years of the term, with the exact amount dictated by the type of loan you get.

We offer 3⁄1, 5⁄1, 7⁄1 and 10⁄1 adjustable rate mortgages, with the first number indicating how many years the rate is fixed and the second reflecting how often the interest is adjusted.

In the case of all the ARMs we offer, the rate is reevaluated on an annual basis. Many such mortgages put a cap on rate increases that is specific to each adjustment or covers the life of the loan.

How the rate is adjusted varies between loans, so it’s a bit challenging to explain generically. The adjustment is based on a variable index, such as the maturity yield on 1-year Treasury bills and the London InterBank Offered Rate (LIBOR), plus a set margin.

2 Pros of Adjustable Rate Mortgages

  • Lower initial rates. In most years, the commitment rate for an ARM is lower than what’s available for fixed-rate loans, which can mean the opportunity to save hundreds of dollars each month. Worth noting: That is not the case right now as historic lows for 30-year mortgages have rates for the two options essentially even.

  • Possibility of lower rates over time. With current performance of the indices, those paying on ARM loans are likely paying less than those who took out 30-year loans even just in the last decade. You only get that opportunity with an ARM.

2 Cons of Adjustable Rate Mortgages

  • Possibility of interest rate increases. That variability can cut both ways and typically does for those who keep the loans for a while after their commitment rates run out. After all, every economic indicator will fluctuate up and down over the course of three decades.

  • ARMs can be confusing. Typically less than 10% of home loans are ARMs, perhaps because many people can’t make sense of the complex option. After all, who keeps up with the LIBOR or can easily understand a rate that can fluctuate on a yearly or even monthly basis? And that lack of understanding can be a problem for borrowers who get an ARM unaware of the possibility the rate could go up.

When it comes to finding the right home loan for your situation, the experts at Journey Home Lending are ready to help. We have the knowledge and industry experience to help you understand your options.