Adjustable-Rate Mortgage (ARM)
Perhaps the most confusing aspect about buying a house is figuring out what kind of mortgage is best for you. One such mortgage is called an adjustable rate mortgage (ARM). As the name suggests, adjustable-rate mortgages have interest rates that can increase or decrease, depending on market fluctuations.
In most cases, there is an initial fixed rate period, during which interest rates stays the same. After that, there are periodical changes at which your payment may be higher or lower than the initial amount. The timeline for these changes is laid out in the initial contract, but the rate usually changes year to year.
Though there may be some uncertainty with adjustable-rate mortgages, they typically have lower initial interest rates than fixed rate mortgages. But markets are unpredictable, so determining your payments over the life of the mortgage is virtually impossible. Though you may go stretches of lower payments, your rate could also go up for an extended period of time.
However, even if your rates go up, there is a limit to how much they can increase, both from period to period and over the life of the mortgage.
Most ARMs are done in a 5/1 pattern. This means the introductory rate is five years. Then, it changes year after year. However, there are other types of ARMs as well, such as 3/1 ARMs, 7/1 ARMs and 10/1 ARMs. If in doubt, ask your banker to lay out the plan in full detail, and get advice from an experienced real estate agent about your best options.