Adjustable Rate mortgage (ARM) also called as variable-rate mortgage is a mortgage loan where payments will fluctuate over time. The initial interest rate will be lower than that of a fixed rate mortgage; however, changes in the market could result in increased interest rates, which will ultimately effect the monthly payments.
For borrowers whose income may go up, an adjustable rate mortgage might be the best options because of early lower payments. Some loans are fixed for a certain period of time, and then they turn into adjustable-rate loans. For example, a 3/1 ARM loan offers a fixed-rate for the first three years, adjusting once a year thereafter. A 5/1 ARM loan offers a fixed-rate for the first five years, adjusting yearly thereafter.
In ARM, the interest rate on the note periodically adjusted based on an index which reflects the cost to the lender of borrowing on the credit markets. Among the most common indexes are:
For the borrower, adjustable rate mortgages may be less expensive, but at the price of bearing higher risk. Many ARMs have "teaser periods", which are relatively short initial fixed-rate periods (typically one month to one year) when the ARM bears an interest rate that is substantially below the "fully indexed" rate. The teaser period may induce some borrowers to view an ARM as more of a bargain than it really represents. A low teaser rate predisposes an ARM to sustain above-average payment increases.
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