What is an Adjustable Rate Mortgage?
An adjustable rate mortgage or an ‘ARM’, as they are commonly called, is a loan type that offers you a lower initial interest rate than most fixed rate loans but the tradeoff is that the interest rate can change periodically, usually in relation to an index, and your monthly payment will go up or down accordingly. Against the advantage of the lower payment at the beginning of the loan, you should weigh the risk that an increase in interest rates would lead to higher monthly payments in the future so essentially - you get a lower rate with an ARM in exchange for assuming more risk.
Here is some detailed information explaining how ARM's work:
What is an adjustment period and how does that effect my monthly payment?
With most ARMs, the interest rate and monthly payment are fixed for an initial period of time. That time period could be one year, three years, five years or even seven years but after the initial fixed period, the interest rate can change every year. At Skowhegan Savings, we offer a five year fixed period on our ARM mortgages, then our interest rate changes are tied to changes in the index rate.
What is an index rate?
An index rate is an interest rate that fluctuates with general market conditions. Using an index to determine future rate adjustments provides you with assurance that rate adjustments will be based on actual market conditions at the time of the adjustment. The current value of most indexes is published weekly in the Wall Street Journal. If the index rate moves up, so does your mortgage interest rate and with that - you will likely have to make a higher monthly payment. On the other hand, if the index rate goes down your monthly payment may decrease.
How do lenders’ prepare for fluctuations in interest rates by using a ‘margin’?
To determine the interest rate on your ARM loan, we'll add a pre-disclosed amount to the index called the ‘margin’. If you're still shopping, comparing one lender's margin to another's can be more important than comparing the initial interest rate, since it will be used to calculate the interest rate you will pay in the future.
Can my interest rate be capped?
An interest-rate cap places a limit on the amount your interest rate can increase or decrease. There are two types of caps:
- Periodic or adjustment caps, which limit the interest rate increase or decrease from one adjustment period to the next.
- Overall or lifetime caps, which limit the interest rate increase over the life of the loan.
As you can imagine, interest rate caps are very important since no one knows what can happen with rates in the future. All of the ARMs that we offer have both adjustment and lifetime caps.
Selecting a mortgage may be the most important financial decision you will make and you are entitled to all the information you need to make the right decision. Visit our rates page to see our current ARM rates and don’t hesitate to contact a Community Banker if you have questions about the features of our adjustable rate mortgages.
