What is an ARM

                                                                                         

There are basically just two kinds of regular mortgages available: an ARM and a fixed-rate mortgage. In mortgage terms, an ARM refers to an “adjustable-rate mortgage”.

The difference between the two kinds of loans is very simple; with an ARM, the amount that you repay each month can vary over a period of time. With a fixed-rate mortgage, you know exactly how much you will be paying each month for the entire mortgage period.

For example, an adjustable-rate mortgage of $350,000 may have a monthly payment of $2,030 at 5.7%. With an ARM mortgage for the same amount, you may only be paying $1,620 at 3.75% per month - a significant saving.

So therefore, it would seem obvious that taking out an ARM mortgage is the best deal and that’s the one people should choose. Well, in theory, that’s correct. In practice, it can be very different.

Remember ARM stands for “adjustable-rate mortgage” meaning your monthly payments could go down or just as easily increase. If that same mortgage, went up by 3% for example, over a period of five or six years, would increase the monthly payment to $2,507. That is an increased difference of $887. Now the fixed rate mortgage looks a lot more attractive.

Quite often, mortgage companies will offer what is known as “teaser” rates, meaning that for the first couple of years, your mortgage payments will be at a considerably very low interest rate and therefore very low monthly payments.

But these ARM payments could and most likely do, jump up considerably in price after the first couple of years, and could also be made worse by an increase in interest rates. These two factors could possibly make the payments too large for the homeowner to handle.

All of this doesn’t mean that an adjustable-rate mortgage shouldn’t be considered alongside a fixed-rate mortgage. It is just very important to consider exactly how much you would be able to afford at the absolute most should the interest rate and your monthly payments increase.

Banks and other institutions will usually offer what’s known as a “cap” on the interest rate. What this means is that no matter how high interest rates might climb, your mortgage payments won’t go above an agreed monthly limit.

Armed with this “capped” figure, you can then calculate if you feel you’d be able to make the payments at this maximum rate. There may be other options such as the rate can only increase by a certain amount each year.

So you also need to consider as many other factors as possible such as increases in your income over time. If necessary, would an additional part-time job cover increased monthly payments?

As long as you gather as much information as possible to compare an ARM with a fixed-rate mortgage, you should be able, with the help of a broker, to come to a decision as to which type of mortgage is the most suitable both for your present situation and any possible changes that may occur.

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