Rates are usually lower than 30-year fixed-rate mortgages for the first five years, which could leave enough room in your monthly budget to pay for a new home. According to the Mortgage Banker Associations, ARM applications represented 7.4% of all purchase requests the week ending August 5, compared to 3.1% at the beginning of the year. One way to save money during the life of the loan when you get an ARM is to allocate the money you save with that lower interest rate directly to the capital. Mortgage lenders offer a variety of options when it comes to the type of financing you can get to buy or refinance a home.
If a borrower hires an ARM with the intention of paying off the mortgage by selling or refinancing before the rate is restored, personal finance or market forces could trap him in the loan and potentially subject him to a rate hike that he cannot afford. An ARM has a fixed rate for the first few years of the loan term, which is often referred to as the initial rate because it's lower than any comparable rate you can get for a fixed-rate mortgage. The most common indices used to calculate ARM rates include the One-Day Guaranteed Funding Rate (SOFR), the Fund Cost Index (COFI) and Constant Maturity Treasury Bonds (CMT). In addition to the different types and terms of loans, you'll need to decide if you want a fixed-rate loan or an adjustable-rate mortgage (ARM) loan.
If interest rates rise, refinancing to a new fixed-rate loan or even a new ARM may not result in as much interest savings. After the end of the fixed-rate portion of the term, the ARM adjusts upwards or downwards depending on current market rates, subject to the limits that govern how much the rate can rise in a particular adjustment. On a 5-year FHA adjustable rate loan, the interest rate will increase one percentage point per year after the first five years, but increases in mortgage rates are limited to five percentage points over the life of the loan. A 5-year ARM may also be a good option for a homebuyer who plans to sell their new home or pay off their mortgage in full within the first five years, before the low initial interest rate on their loan expires.
ARMs are attractive to many buyers because, initially, they offer lower mortgage rates than fixed-rate loans. When looking for home loans, you'll need to decide between a fixed-rate mortgage or an adjustable-rate mortgage.