Adjustable Rate Mortgage - Defined
The adjustable rate mortgage, or ARM, is a popular loan option for home buyers who want a lower interest rate during the first years of the loan's term. In this context, "lower" means a lower interest rate than the borrower would receive on a traditional fixed-rate mortgage loan.
That's the primary reason most people choose an adjustable rate mortgage in the first place — to reduce their monthly mortgage payments during the first few years of the loan.
Notice I said "first few years" of the loan's term. This is a key concept of the adjustable rate mortgage loan. Most ARMs start out with a fixed interest rate for the few first few years. This rate is often lower than the interest rate you would get on a traditional fixed-rate loan (advantage).
But after this introductory period -- usually 3, 5 or 7 years -- the adjustable-rate mortgage will adjust to the prevailing interest rate at the time of adjustment. This adds an element of unknown risk into the equation (disadvantage).
Refinancing the ARM Prior to Adjustment
The common strategy with an adjustable-rate mortgage is to either (A) refinance the mortgage prior to adjustment, or (B) sell the home prior to the adjustment. In either case, the homeowner can take advantage of the of the lower interest rate during the initial period, while avoiding the uncertainty of the interest rate adjustment period.
Visit the Home Buying Institute to learn even more about adjustable rate mortgages.