An Adjustable Rate Mortgage (ARM) is typically a mortgage that is fixed for a period of time, and then becomes adjustable. The typical ARMs are 3/1, 5/1, 7/1, and 10/1. The first number represents the time period the rate is fixed. The second number represents how often the rate changes.
Example: A 3/1 ARM means the rate is fixed for 3 years, and then adjusts each year thereafter. The loan typically has a 30 year term.
When the loan adjusts, it adjusts to an index plus a margin. The index is typically the 1-year LIBOR (London Interbank Offered Rate). The margin is a fixed factor, such as 2.25%. So, for a 3/1 ARM, in year 4, the rate adjusts to the 1-year LIBOR rate plus a 2.25% margin. If the 1-year LIBOR rate is 1.85% in year 4, then the rate would be 4.1% (1.85% + 2.25%). If the LIBOR increases to 2.1% in year 5, then the rate for the 5th year of the loan would be 4.35% (2.1% + 2.25%).
ARM rates are typically lower than 30-year fixed rates. If you know you will only be in the home for a short period of time, e.g. 5 years, then you may want to consider a 5/1 ARM as the rate will be fixed at the lower rate for 5 years.
There are many people who chose an ARM in the early 2000s, and still have the same loan today. As rates have stayed low, the adjusted rate has remained low. However, as we are now into an increasing rate environment, the index will likely increase, and so will the rate. Thus, it may now be time to consider refinancing into a fixed rate mortgage.
If you have an ARM, or are considering financing with an ARM, contact us and we can help you determine if it is right for you.
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