When you shop for a mortgage, whether it’s for a new home or a refinance, you’ll soon hear about adjustable-rate mortgages (ARMs).
While ARMs definitely have their advantages, make sure you understand them before getting into one.
How ARMs work
All ARMs start out as fixed-rate mortgages. An ARM will appear like this, where the first number in the terms “3/1,” “5/1” or “7/1” denotes the number of years that the rate will be fixed. Usually the lower the number, the lower the initial rate.
The second number shows how many years before the rates can be adjusted once that fixed period has expired.
After this fixed period, the rate can fluctuate. The rate itself is made up of both fixed- and variable-rate components.
The variable component will be based on some index such as Treasury bonds. This is added to the fixed-rate component set by the lender when you determine your starting rate.
Your decision to obtain an ARM should be based on how long you plan to live in this home.
If you believe that you could be living there for a long time, you may want to consider opting for a fixed-rate mortgage.
The reason? If you have an ARM and have to refinance at some time in the future when rates are higher, you might find yourself in a fixed-rate mortgage with a much higher rate.
Talk to your advisor about whether an adjustable-rate mortgage is right for you.