What Is an Adjustable-Rate Mortgage?

Let’s review the basic adjustable-rate mortgage definition before diving into greater detail.

An adjustable-rate mortgage (ARM) is any loan where the interest can vary through the lifetime of the loan. At first, the initial interest rate is usually set below the market rate, but it can rise as time goes on based on what the interest adjustment frequency is. Adjustable-rate mortgages will have a cap on how much an interest rate can be adjusted in a period, and a ceiling on how high the rate can get during the life of the loan.

An adjustable-rate mortgage can be applied to nearly any type of loan you take out, whether that be a VA loan, conventional, Non-QM loan, FHA loan, or jumbo loan.

Generally, adjustable-rate mortgages are best suited for those—and offer the best savings—who plan to either refinance or move after the initial interest period.  

 

How Does an Adjustable-Rate Mortgage Work?

Need further clarification? Here’s some more detailed insight into how adjustable-rate mortgages work in practice.

  • Interest rates are fixed for a period of years. The most popular mortgages are 5 or 7 years with a fixed introductory rate and then a changing interest rate every year after that. After your fixed-rate period, interest rates can adjust up or down depending on market conditions.
  • After the fixed-rate period is over, your interest rate may go up or down based on which index it is tied to. 
  • Your mortgage can have different caps which can protect you from large increases. They can limit how much your rate changes in a year, limit how high the interest rate can get over the life of the loan, or place a limit on how high your monthly payment can be.
  • You can pay off your mortgage early without prepayment penalties

If you still have questions about adjustable-rate mortgages when you’re finished reading this page, our loan specialists are happy to provide further clarification.

How Much Can an Adjustable-Rate Mortgage Increase?

At Griffin Funding, rate adjustments are capped at 5% above your initial rate and 2% or 5% per adjustment period, in most cases. 

Take this adjustable-rate mortgage example: if you start at a rate of 3.75%, your rate can’t be higher than 8.75% and will not increase more than 2% per year. 

However, interest rates are not guaranteed to increase. If the interest rates have decreased since you got your initial rate, your adjustment may actually decrease over the life of your loan.

Keep in mind that rate adjustments may vary by lender.

Adjustable-Rate Mortgage vs. Fixed-Rate Mortgage

A fixed-rate mortgage is a conventional loan, set over a period of time usually between 10 to 40 years. It has the same interest rate every month which is based on several factors including income, credit score, down payment, etc. which differs from an ARM which has interest rates which are more sensitive to the market. Your payments won’t change over the life of your mortgage, which will allow you to have a consistent loan payment.

What Are the Advantages of an Adjustable-Rate Mortgage?

There are several benefits of an adjustable-rate mortgage over a fixed-rate mortgage:

  • An adjustable-rate mortgage will usually have a lower introductory interest rate than a fixed-rate mortgage will. This means that if you can pay off most of your loan within the introductory period, you will have saved money in the first five to seven years of your mortgage.
  • Without having a fixed interest rate, borrowers can take advantage of the market of historically low interest rates instead of refinancing. Because there are no closing costs or fees, the borrower can take advantage of the rates fall, and their monthly payments will match.
  • If you think your income is going to greatly increase in the future, an ARM can keep your mortgage payments lower in the beginning of the loan, and then when your income increases, the higher interest rates won’t be as much of a problem, allowing you to get a property earlier than you would with a fixed-rate loan.
  • If you plan on flipping a house or only being a short-term owner, an ARM makes a lot of sense. You can get your use out of the house before the initial rate is up and then move or sell when it is up.

Think an ARM is right for you? Apply online today to get the process started.

What Are the Disadvantages of an Adjustable-Rate Mortgage?

As with any type of loan, an ARM isn’t the right best solution for everyone. Here are some of the potential drawbacks:

  • When interest rates rise or fall based on the market standards, your rates and payments can change as well, making it difficult to budget out how much your future payments may be. 
  • Some ARMs on investment properties can come with a prepayment penalty which is charged if you refinance or sell.
  • They are complex. There are typically more rules, regulations, and fees on an adjustable-rate mortgage than there are on fixed-rate loans.

Is an Adjustable-Rate Mortgage a Good Idea?

There are circumstances where getting an ARM is the best mortgage option. Whether you are getting a loan for the short-term, or you feel like you can predict where the rates are heading, getting an ARM might be the ideal solution for you. Of course, your personal circumstances should dictate which loan you pursue. 

The right type of loan for you depends on your specific circumstances. When in doubt, speak with one of our knowledgeable loan specialists before completing your initial application.

Apply for an Adjustable-Rate Mortgage Today

Whether or not an adjustable-rate mortgage is the best mortgage program for you, Griffin Funding can help you secure a home loan that fits your needs and financial situation. In addition to conventional loans, we also offer non-QM loans that are typically better suited for borrowers with more complex financial situations. No matter what type of loan we help you with, we always provide white-glove five-star service and strive to make the lending process as streamlined as possible. Apply now or give us a call today to get the process started.