Adjustable-rate mortgages (ARMs) are loans with an interest rate that can change throughout the term of the loan. The two periods of an ARM are the “initial period” and the “adjustment period.”
The initial period is the “fixed rate” window of the loan. During this time, the interest rate on your loan cannot change. The fixed rate window can range from six months to 10 years, the most common being a period of 3, 5, or 10 years.
After the initial term ends, the adjustable period starts. The main part of this period is when your interest rate may change. The terms of your ARM should be made clear by the lender upfront, such as rate cap structure, margin and index so you can understand how your rate can vary in the future.
- Initial cap – limits how much your rate can increase during your first rate adjustment
- Periodic cap – limits how much your rate can increase from one adjustment period to the next
- Lifetime cap – limits how much your rate can increase or decrease over the life of the loan
The best times to consider an ARM loan are if you’re either planning on moving or selling your home within five years (or before the adjustment period), or if fixed rates are high when you buy your home.
What to do when your ARM is due
If you have an adjustable-rate mortgage (ARM) and your fixed-rate period is drawing to an end, that means your first rate adjustment is coming up. It's time to make a plan.
Start by reviewing the ARM you have. How often can the rate adjust? How much can the rate rise at each adjustment? How much will your monthly payment increase at each adjustment? What's the limit on the rate increase over the life of the loan? If you need some help answering these questions, give us a call!
When your ARM comes due for an adjustment, you have three choices:
- Refinance into a fixed-rate 30-year (or shorter term) mortgage. You won’t have to worry about rate adjustments again. However, fixed-rate loans have higher interest rates than ARMs. You'll also have to pay closing costs to refinance. If you have enough equity those costs can be rolled into the loan amount.
- Refinance into a new ARM that has terms better suited to your situation. You'll face the decision again in a few years about what to do when the rate adjusts. Still, a new ARM might be a viable option if you plan to sell your house in a couple of years. You'd save a bit on monthly payments in the meantime. Remember to factor in closing costs.
- Stay with the ARM you have and take the rate adjustment. If you have a low-rate ARM and it can't climb much, you might want to stay in it for the remaining few years and see what happens—if you don’t mind the uncertainty. It also makes sense to stay in your current ARM if you plan to sell your home soon.
If you need help deciphering your ARM contract and planning your next move, call our local team. We can look at your situation and help you find the best option. Visit us online at directfinancial.com to make an appointment or call 800.966.8200 to speak with a loan expert!