Adjustable-rate mortgages are making a comeback. A recent article in The Wall Street Journal says financial groups are offering sweeter deals in an effort to attract customers. But what exactly is an adjustable-rate mortgage?
An adjustable-rate mortgage (ARM) is a loan with an interest rate that changes. The ARM may start with a low monthly payment, but then it goes up after a certain amount of time.
Depending on the type of loan you get, the lender can allow the rate to adjust monthly, quarterly, annually, every three years, or every five years.
Three different types of ARMs are hybrid, interest-only, and payment option.
Hybrid ARMs often are advertised as 3/1 or 5/1 ARMs. These loans are a combination of a fixed-rate period and an adjustable-rate period. Says the Consumer Financial Protection Bureau, “the interest rate is fixed for the first couple of years —for example, for 5 years in a 5/1 ARM. After that time, the rate may adjust annually (the 1 in the 5/1 example), until the loan is paid off.”
An interest-only ARM allows you to pay only the interest for a specific number of years (usually for three to 10 years). After that time, you’ll have to pay back the principal as well as the interest each month.
A payment-option ARM is an adjustable-rate mortgage that allows you to choose among several payment options each month.
One risk involved with an ARM is that you could end up owing more than you originally borrowed. Another risk is that if you decide to pay off your ARM before it is due, you could be required to pay a penalty.
Sources: Consumer Financial Protection Bureau, About.com