There are many mortgage products available on the market today, which is great for buyers who now have more than one option for purchasing a home. There are your traditional 15-year or 30-year fixed rate mortgage loans (which are often just called conventional mortgages), adjustable rate mortgage loans, balloon payment loans, jumbo loans, variable term mortgage loans - - what do they all mean?!?! And of course most importantly: which one is the right choice for you and your family?
One popular mortgage loan product is adjustable rate mortgages, or ARMs. ARMs generally are advertised as 5, 7 or 10 year (or 5/1, 7/1, and 10/1) ARMs, although some mortgage lenders may offer other loan terms. When you see an ARM advertised as a “5/1” or “10/1”, the first numerical number tells you when how long the initial interest rate period will last. So, if you were to obtain a 5-year ARM, your initial interest rate would be locked in and remain the same for the first 5 years of the loans period, at which point it would either increase or decrease based on the then-current mortgage interest rates and your then-current financial situation (i.e., your credit score, earnings, assets and debts). The second number in the ARM ratio (the 1 in a 5/1 ARM) tells you how many times per year your interest rate may fluctuate. With a “1” option, which is the most common ARM option, your mortgage interest rate may fluctuate up or down only once per year.
What are the advantages and disadvantages of an ARM as compared to a fixed-rate mortgage?
With a fixed-rate mortgage, your interest rate and monthly payments remain the same throughout the life of your loan, which can be enticing to many buyers as that means that they know what they will pay each month for the next 15 or 30 years. For those buyers who believe that their personal financial circumstances will change significantly within the next couple of years, an ARM may be very beneficial as the initial interest rate term is generally much lower than that of a fixed-rate mortgage loan.
The main disadvantage of an adjustable rate mortgage loan is that it is often riskier than a fixed-rate mortgage loan. One protection against that risk is the interest caps on ARMs, which protect borrowers from extreme upward interest rate fluctuations.