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How an Adjustable Rate Mortgage (ARM) Works

It’s natural for people to avoid the unknown because there is room for doubt and uncertainty. An Adjustable Rate Mortgage (ARM) is often misunderstood as being a “risky” loan, probably because many people are uniformed on how the loan works.

In many cases, an ARM is more beneficial and makes better financial sense than a 30 year fixed mortgage.

How an ARM Works

A hybrid ARM consists of two parts, a fixed period and an adjustable period.

Type of ARM

The first thing to understand about ARMs is their fixed period and adjustable period. At HFC we offer 4 types of ARMS: 3/1, 5/1, 7/1, and 10/1.

What does that mean?

The first number represents the amount of years of the fixed period. A 5/1 for example, means that your initial interest rate will remain fixed for 5 years before it adjusts.

The second number represents how often the rate will adjust. In our previous example of a 5/1 , that means that the interest rate will adjust once every year after the initial 5 year fixed period.

Initial Rate

The initial rate is the rate that is offered at the beginning of the loan and remains fixed until the adjustment period. The initial rate of an ARM is usually much lower than that of a 30 year fixed mortgage.

Adjustment Period

The adjustment period is the time at which the interest rate will adjust either higher or lower depending on current market conditions. In our case, the adjustment will occur once a year after the initial fixed period.

Index

The index is made up of two parts, your initial rate based on market conditions and a margin. The margin is an extra amount that the lender adds.

Caps

To avoid rates from adjusting too high, caps are set for every ARM. A periodic adjustment cap limits the amount a rate can adjust from period to period. By law, a lifetime cap is set to limit how high a rate can increase over the lifetime of a loan.

Why Choose an ARM?

  • Lower initial rate
  • Flexibility of term length
  • Ability to pay off early
  • Ability to convert

There are many benefits to an ARM, but the biggest is the low initial interest rate offered which can save a person thousands of dollars a year compared to a higher rate with a 30 year fixed. The program also gives a person flexibility by allowing them to choose their fixed period term (3,5,7 or 10 years).

Many people who choose an ARM plan to take advantage of the lower interest rate and flexible term to pay the loan off sooner. The idea is to try and pay the loan off during the fixed period to avoid the adjustment and save money on interest. Although if a person is unable to pay off the loan before the adjustment period, they always have the option of converting their loan to a 30 year fixed.

For more information on how an ARM works or if the program is right for you, give us a call at 1-800-308-4999 or email us at inquiries@hf-corp.com

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