An adjustable rate mortgage (commonly called an ARM) is a mortgage product that typically offers a lower introductory interest rate for a fixed period, but after that fixed period expires the interest rate will change based on the market rate.  Most loans will offer a low interest for 5 or 7 years, and then change annually by adding a fixed amount (say 2.25%) to the market rate.

As an example, if you closed on a loan today that had a fixed interest rate of 3.5% for 5 years, but then became adjustable by adding 2.25% to the market rate, your principal and interest payments would not change until 2018.  Then in 2018, your rate will change by adding 2.25% to the market rate (typically based on the LIBOR).  The LIBOR stands for London Interbank Offered Rate and is published everyday in the Wall Street Journal.  Today, the LIBOR rate is approximately .7%.  (If the change was based on today’s rate, the interest rate would be 2.95%, which would actually lower the monthly payment). 

Once the adjustments are made, they are typically made once per year and most ARM products have a cap of 5.00% above the introductory rate.

Why would anybody get an adjustable rate mortgage when fixed interest loans are available?  This is something to discuss with your loan officer, but the prospect of paying less in interest for the first 5 to 7 years is very appealing particularly if you plan on selling your home within that 7 year time frame.  However, it is important to acknowledge that even if you do plan to sell your home, it is possible it will take longer than anticipated.  Consequently, if you elect an ARM, you must be comfortable with the terms even if you do not plan on carrying the loan for that long.

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DISCLAIMER: This article is intended for informational purposes only and does not constitute legal advice. You should not rely or act upon any information contained in this article without seeking the advice of qualified legal counsel.