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How Risky are ARM Mortgages

Should I Get An Adjustable Rate Mortgage?

An Adjustable Rate Mortgage, or ARM, is a valuable home mortgage financing option that can offer a wide range of extremely secure solutions for the right person.

Adjustable mortgages got a bad name in the sub-prime days by being associated with 2 year fixed loans, and option ARM mortgages that offered partial payment options that didn’t even cover the interest due on the loan.

The fact is, Adjustable Rate Mortgages are extremely secure and carry no surprises if your loan officer does a good job of explaining how the loan works.

ARM Terms and Definitions

Fixed Rate Period – ARM mortgages are typically fixed for period of time, and then begin to adjust after that.  Common Fixed Rate Periods for ARM loans are 5 years, 7 years and 10 years.  These loans have names like 5/1, 7/1 & 10/1 ARM.

Adjustment Period – With a 5/1, 7/1 & 10/1 ARM, the first number represents the number of years the rate will be fixed, and then, once the fixed period is up, the second number – usually 1 (year), will tell you how often the rate can adjust.

Adjustment Caps – The adjustment caps determine the maximum amount that an interest rate can adjust, either up or down.  Ask your lender for a full disclosure of the terms of your ARM.  Adjustment caps will often describe the initial adjustment period, the maximum a rate can adjust during the adjustment period, and the maximum a rate can adjust during the life of the loan.

Index – The index is the money market fund used to determine the baseline for which the interest rate adjustment is made.  The most common ARM Indexes are the London Interbank Offered Rate (LIBOR), or the 1 Year US Treasury.  An internet search will give you the current and historical LIBOR index rates

Margin – A Margin is what is added to the margin to determined the newly adjusted rate.  Margins can range, based on the type of loan.  A common ARM margin would be 2.25%.

What Happens After My ARM Adjusts?

Let’s use a FHA 5/1 ARM as an example for calculating the possible adjustment.

  • Starting rate:  3.25%
  • Adjustment Caps:  1/1/5
  • Index:  1 Yr U.S. Treasury – currently at .16%
  • Margin:  2.25%

On the 61st month, the interest rate would adjust to the Index .15% + the margin of 2.25%, which would make your adjusted rate, if it were to adjust today, decrease to 2.41% for the next year.

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Avoid Surprises with ARM Mortgages

Now that you understand the basics of your ARM mortgage, it’s important that you ask the right questions of your loan officer to make sure you know exactly what the terms, caps, margin and index is for your ARM.

You are now prepared to make an informed decision about which ARM, if any, will meet your financial goals.

Once the fixed period of your ARM is up, your lender will send you a notice prior to the adjustment of your ARM mortgage so there should never be any drastic surprises.  The adjustments to your loan are easy to calculate once you know how.

Choosing the Right ARM

There are many reasons to choose an ARM mortgage.  Some of the more common reasons are:

  • Refinancing likely to access equity in near future
  • FHA with permanent mortgage insurance only option at this time
  • Do not plan to stay in home for longer than 5,7 or 10 years

If you’re not sure if an ARM mortgage is right for you, if you still have questions about ARM mortgages, or if you have an ARM mortgage now and you would like to know what to expect when it adjusts, you can give us a call, shoot us an email, or leave me a question or comment below and we’ll answer all of your questions.

About the Author

Scott Schang

A 20+ year veteran of the Mortgage and Real Estate industry, I am passionate about educating and empowering consumers. I have been writing about consumer protection issues and making sense of complicated real estate and mortgage topics on this website since 2007

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