Understanding the Adjustable Rate Mortgage and How It Works

August 18, 2015
Last updated:
December 6, 2021
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Summary: When applying for a new home loan, there are several different types of mortgage programs available to most applicants in Seattle that you should know about. In this article, we’ll discuss one particular mortgage product that many buyers might find useful: adjustable-rate mortgages.

While there are various home loan programs to choose from, the most significant difference between the various options relates to a fixed-rate mortgage or an adjustment-rate mortgage. Understanding what an adjustable rate mortgage, or ARM, is in comparison to a fixed rate mortgage can help applicants make a more informed decision about their mortgage plans.

What is an Adjustable-Rate Mortgage (ARM)?

An adjustable-rate mortgage (ARM) is one that comes with an interest rate that will fluctuate periodically over the life of the loan, and the mortgage payment will also fluctuate as a result. With this type of home loan, the interest rate will initially be fixed for a certain period of time. After that period expires, the interest rate will reset over specific intervals.

ARMs are typically expressed with two numbers. The first number represents the initial time period whereby the interest rate remains fixed. It’s this time period that the rate will be what you were initially quoted. Once that period expires, the rate will fluctuate at various intervals. That’s where the second number comes into the picture, which represents how often the interest rate will fluctuate.

For instance, a 5/1 ARM means that the fixed rate will remain in effect for 5 years (represented by the first number) and the rate will change every year (represented by the second number). A 3/1 ARM means that the fixed rate will remain in effect for 3 years and will adjust every year after that 3-year time frame ends.

It should be noted that adjustable-rate mortgage have limits that are set in terms of how high the interest rates or payments can go per year or over the mortgage term.

You can see how this differentiates from a fixed-rate mortgage, which is one with an interest rate fixed for the entire term length. This means that a home loan with a 30-year term has an interest rate that will remain the same for the full 30 years, and this also means that the mortgage payments will remain the same over 30 years.

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How is an ARM Beneficial?

There are several benefits associated with an ARM. For example, the initial interest rate and related mortgage payment are typically lower than with a fixed rate mortgage. In addition, if rates decrease over the life of the loan, the mortgage payment will lower as a result without the need to refinance to take advantage of the lower rate.

An ARM may be ideal for those who are planning to sell their home before the initial time period period is up. In this case, buyers can take advantage of the lower initial interest rate and sell before their interest rate changes (especially if rates are higher and would therefore increase).

Before Applying for an ARM

Before applying for an adjustable rate mortgage, there are a few points that the applicant should keep in mind. Just as the interest rate may go down over the life of the loan, the rate and the mortgage payment may increase. The loan applicant should ensure that the upper limit for the interest rate and mortgage payment will be affordable for their personal budget before applying for this type of loan.

It’s also important to understand that the initial fixed rate that applies tot he initial time period can increase in the future when the rate adjusts. This is a risk that borrowers will need to take. But if rates are expected to decrease in the near future, borrowers with an ARM can realize lower rates after the initial time period ends, which can save them money.

Each loan program available to a mortgage applicant has its pros and cons, and this holds true for an adjustable rate mortgage as well. Understanding how each loan program works and what the benefits and drawbacks for each are can help an applicant make an informed decision when applying for a mortgage. Those who are interested in applying for a new mortgage for a purchase or a refinance in the coming days or weeks may reach out to Seattle mortgage broker to inquire about the different loan programs available in Seattle.

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Have Questions About Adjustable-Rate Mortgages?

Whether you’re contemplating taking out an adjustable-rate mortgage or any other type of home loan, we can help. Sammamish Mortgage is a local, family-owned company based in Bellevue, Washington that has been serving the entire state since 1992. We serve the entire Pacific Northwest region that includes Idaho, Colorado, Washington, and Oregon. We offer a wide variety of mortgage programs and products with flexible qualification criteria. Please contact us if you have mortgage-related questions.

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