What is an ARM loan?
Adjustable-rate mortgage (ARM) loans are home loans that typically have lower interest rates than fixed-rate mortgages. With a fixed-rate mortgage, the interest rate is the same for the entire life of the loan. With an ARM loan, the interest rate adjusts after a fixed period of time (e.g., 1, 3, 5 or 7 years) which means monthly payments can go up or down.
Interest rates are generally lower for ARM loans because the borrower assumes part of the risk. If the interest rate rises, the lender benefits. If the interest rate falls, the borrower benefits. Interest rates and therefore ARM loan payments can fluctuate over time. To help balance this risk, ARM loans are subject to “caps” or limits on the total rate change over the life of the loan.
Borrowers willing to assume the risks associated with ARM loans can lower their initial payments. In some cases, lower interest rates can help borrowers qualify more easily for a home loan. If interest rates remain steady, ARM loans can even be less expensive than fixed-rate mortgages.
There are a number of other reasons why borrowers might benefit from ARM loans. The initially lower payment can free up money early on. Borrows should just beware of the potential risk that the loan will adjust higher and be prepared for that possibility. ARM loans can also help borrowers qualify for higher loan amounts. Finally, ARM loans could be a better option than higher rates paid on fixed-rate loans if the borrower plans to move in the next few years.
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