ARM Loans Explained - A Guide to Adjustable Rate Mortgages

If you’re considering buying your first or next home, you may want to think outside the box when it comes to financing the purchase – especially in today’s tough housing market. A unique option you may not know much about is an adjustable-rate mortgage, or ARM loan. 
 
Read on to learn the basics of adjustable-rate mortgage loans, potential benefits and more - or use the links below to skip to a specific section:

• What is an ARM loan
• How does an ARM loan work
• Potential interest rate changes
• Difference between an ARM loan and a fixed rate mortgage
• Benefits and why choose an ARM loan

 

What is an adjustable-rate mortgage (ARM)?

Like all mortgages, an ARM loan pays for the purchase of a home. The key component of an ARM loan is the adjusting interest rate, which changes over the life of the loan, unlike a fixed rate mortgage.
 

How does an adjustable-rate mortgage loan work?

Merchants Bank offers ARM loans in varying terms, for example a 10/1 or 7/1 ARM. The first number in the name represents the number of years the initial interest rate of the loan will be fixed, which is also known as the initial loan period. So, for a 10/1 ARM, the initial interest rate is fixed for the first 10 years of the loan and then will adjust. In addition to the interest rate adjusting, your payment may increase after the initial period.
 
Typically, the rate of an ARM loan during the initial interest period is lower than the interest rate on a traditional fixed rate mortgage. This also means your monthly payments may be lower during the initial period.
 
When the initial interest period is over, the interest rate of your loan will adjust (increase or decrease) based on a calculation of margin plus index. The margin is set by the specific bank you are working with and the index for your loan is selected from index options pre-approved by the Federal government. As the index figure moves up and down, your interest rate will change accordingly, on an annual basis.
 

How much could the interest rate increase on an adjustable-rate mortgage after the initial interest period?

That’s the big question, right?
 
An ARM loan has an interest rate cap built in, which should minimize wide swings in the interest rate after the initial period. Caps are either set annually or for the life of the loan and will vary by the loan term. For example, at Merchants Bank the interest rate caps on our ARM loans have an annual increase or decrease of two percentage points or life of loan increase or decrease of six percentage points.
 
Ultimately the change in rate depends on the economic environment at the time of the adjustment, which impacts the index figure.
 

What’s the difference between an adjustable-rate mortgage loan and traditional fixed rate mortgage loan?

When comparing an ARM loan and a traditional fixed rate mortgage, it helps to keep these key details in mind.

Loan Details	Adjustable-Rate Mortgage Loan	Traditional Fixed Rate Mortgage Loan
Rate type	Adjustable, changes during the life of the loan.	Fixed, stays the same during the life of the loan.
Monthly payments	Based on principal and interest, which adjusts after the initial interest period.	Based on principal, interest and private mortgage insurance (if applicable), which is fixed for the life of the loan.
Term	Typical terms are available.	Typical terms are available.

 

Why choose an adjustable-rate mortgage loan?

There are benefits to ARM loans over other types of financing, especially if you are planning to sell your home in a few years. 

Benefits of an ARM loan:

• Lower initial rate. Your rate during the initial period of the ARM loan will often be lower than the rate on a traditional fixed rate mortgage.
• Lower monthly payments. Merchants Bank does not require monthly private mortgage insurance (PMI) on ARM loans kept in-house. This combined with the lower rate during the initial period means you can expect to have lower monthly payments. Note: PMI may be required on secondary market loans.
• Potential cost savings. With these two things in mind, you may be able to realize some big savings on mortgage payments during the initial interest period.
• Great option if you’re planning to sell in a few years. When considering your plans, how long do you see yourself in this home? If it could be less than the initial interest period, an ARM may be a great fit because you’ll realize the savings of lower interest and payments and sell before the rate adjusts. For example, if you have a 10/1 ARM, selling within the first 10 years of the life of the loan may be ideal.
• …or, if you might refinance. The benefits around selling within the initial period also apply if you think you might refinance your mortgage.*

How do I know if an adjustable-rate mortgage loan is right for me?

There are many factors that can go into determining which kind of home loan is right for you – whether it’s an ARM loan, a traditional fixed rate mortgage or another type of specialty mortgage loan program.

Your local mortgage lender can help you decide based on your own situation what makes the most sense for you. Call or email a lender today to start discussing your options.

What are today’s adjustable rate mortgage loan rates?

You can find the rates for adjustable-rate mortgages at Merchants Bank on our rates page. Once there, select your branch and choose mortgage rates to find rates specific to your location.

If you have additional questions about ARM loans or any of our mortgage options, talking to a local lender is a great place to start.