ADJUSTABLE-RATE MORTGAGES

An Adjustable-Rate Mortgage, ARM, is a house loan with a variable interest rate that can fluctuate on a regular basis. This implies that the monthly payments might change. The initial interest rate is often lower than that of a similar fixed-rate mortgage. After that term expires, interest rates — and your monthly payments — may rise or fall. Interest rates are volatile, however, they have tended to trend up and down across multi-year periods in recent decades. Although interest rates are likely to rise this year, they remain historically low, making fixed-rate mortgages the more popular option for the time being. ARMs are generally suitable for borrowers who do not intend to stay in a house for an extended period of time or who live in a high-rate location.

TYPES OF ADJUSTABLE-RATE MORTGAGES

The classic adjustable-rate mortgage is a hybrid ARM. The loan begins with a fixed interest rate for a few years (typically three to ten), after which the rate changes up or down on a predetermined timetable, such as once a year.

01. HYBRID ARM

Interest-only adjustable-rate mortgages (ARMs) are adjustable-rate mortgages in which the borrower only pays interest (no principle) for a defined period of time. When the interest-only period expires, the borrower is required to make full principle and interest payments. The interest-only term might extend anywhere from a few months to a few years. During that period, the monthly payments will be modest (since they are merely interest), but the borrower will not be able to develop equity (unless the home appreciates in value).

02. INTEREST-ONLY ARM

Borrowers can choose their own payment structure and schedule with a payment-option ARM, such as interest-only; a 15-, 30-, or 40-year term; or any alternative payment equal to or more than the minimum payment. (The minimum payment is based on a normal 30-year amortization at the loan's starting rate.) A payment-option ARM, on the other hand, may result in negative amortization, which means the balance of your loan grows since you aren't paying enough to cover interest. If your loan debt climbs too much, your lender may recast it and ask you to make significantly bigger, perhaps unaffordable, payments.

03. PAYMENT-OPTION ARM

VARIABLE RATES ON
ADJUSTABLE-RATE MORTGAGES

Weekly constant maturity yield on one-year Treasury bill — The yield on government debt instruments issued by the United States. According to the

Federal Reserve Board, the Treasury is paying.

11th District Cost of funds index (COFI) - The interest rate that banking institutions in the Western United States pay on deposits.

The Secured Overnight Financing Rate (SOFR) — As the benchmark rate for ARMs, the SOFR has superseded the London Interbank Offered Rate (LIBOR).

PROS

A cheaper starting interest rate means lower monthly payments and the ability to put more money toward the principal.
The interest rate and monthly payments may be reduced.
The interest rate cannot climb over the ceiling level.

CONS

Even with the maximum set, interest rates and monthly payments may grow to unmanageable levels.
The structure that is more intricate and may be difficult to grasp
The possibility of a prepayment penalty