What Is An ARM Versus Fixed Rate Mortgage

This BLOG On What Is An ARM Was Updated On March 12, 2017

ARM stands for adjustable rate mortgage. Adjustable Rate Mortgage is when the mortgage interest rate of the mortgage loan is not fixed for the 30 year term of the mortgage loan. The mortgage interest rate is fixed for the initial rate period which is normally 3 years, five years, seven years, or ten years. After the fixed rate period has elapsed, it may change dependent on the movement of the index the loan is based on. Fixed Rate Mortgages are loans that have the same fixed rate throughout the term of the loan. For example, on a 30 year fixed rate mortgage, the interest rate will remain constant throughout the entire 30 year term of the loan.

Mortgage Rates On Adjustable Rate Mortgages

The adjustable rate mortgage that is normally quoted is the initial start rate of the lender. This rate is good for the initial rate period of a certain amount of years which normally does not exceed 10 years.

Here is how mortgage rates works

  • The mortgage rates is higher if the fixed rate period is longer
  • For example, a 3/1 has a lower rate than a 10/1 
  • ARM interest rates are generally lower than 30 year fixed rate mortgage interest rates because the lender is not tied down to a 30 year lock on a specific interest rate and is only liable for a certain time frame

Strategies Using Adjustable Rate Mortgages

Homeowners who intend on only staying on their home purchase for ten or less years, especially first time home buyers, should consider an adjustable rate mortgage versus fixed rate mortgage due to lower interest rates. Borrowers who have lower credit scores due to their low credit are getting a higher mortgage interest rates and intend on refinancing in the future after their credit profile increases should consider an ARM versus a fixed rate mortgage. Homeowners not sure on how long they intend on staying on their home purchase, their decision will determine the amount of savings the ARM product has versus the fixed rate mortgage. Loan officers can go over each individual case scenarios with borrowers on which mortgage product is best for the borrower.

Rate Adjustment

Borrowers of adjustable rate mortgages need to consider the mortgage rates once the initial start rate period is over. Once the initial starter fixed rate period is over, the mortgage interest rate will adjust each year for the remaining 30 year term of the loan or the term of the loan. Most lenders offering adjustable rate mortgages will have a 30 year amortized term but there are commercial lenders that will amortized it over 15, 20, and 25 years.

Here is how mortgage rates adjustments work on adjustable rate mortgages

  • Adjustment rate is based on the index PLUS margin
  • The margin is a fixed number 
  • The index is what changes and determines the new mortgage interest rates
  • Lenders decide on what index they base their ARM products
  • Whatever the index is plus the margin will be the new adjusted mortgage rate

Analyzing Adjustable Rate Mortgages

Here is how adjustable rate mortgages are analyzed:

  • Value of the index and rate 
  • Add the margin to the index
  • Adjustment rate period is after the fixed rate period is over
  • Add margin to the new index and it adjusts every year for the duration of the term of the loan
  • There is a cap on the interest rate adjustment which limits the size of the interest rate changes plus maximum interest rate over the life of the mortgage

There are pros and cons with going with Adjustable Rate versus fixed rate mortgages. Borrowers who have any questions on which mortgage products is better for them and benefits them more, please contact Gustan Cho at 800-900-8569.

The information contained on Gustan Cho Associates website is for informational purposes only and is not an advertisement for products offered by The Gustan Cho Team @ Gustan Cho Associates or its affiliates. The views and opinions expressed herein are those of the author and/or guest writers of Gustan Cho Associates Mortgage & Real Estate Information Resource Center website and do not reflect the policy of Gustan Cho Associates Lenders Network, its officers, subsidiaries, parent, or affiliates.

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