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How Does an Adjustable Rate Mortgage Work?


An adjustable rate mortgage is a type of loan that has a variable interest rate. For borrowers, the most distinguishable difference between a traditional fixed-rate loan and an adjustable rate mortgage loan is that the payment amount can go up or down, sometimes drastically. The interest rate of an adjustable rate mortgage is determined by an index and can change on a monthly, semi-annual or annual basis depending on the lender.

Three Things Consumers Need to Know

While an adjustable rate mortgage looks like an attractive option, for most borrowers it will result in higher costs over the long run. The initial interest rates and resulting low payments are attractive to borrowers who expect to have increased earnings within several years of purchasing their home. Payments do not generally go down. This means that the initial low payments will change and never return to that initial amount in most cases. Finally, borrowers frequently end up owing more than they expected with adjustable rate mortgages. A common situation is that a borrower who has made all of their payments on time will end up owing a lump sum at the end of the loan period.

Three Things to Consider Before Applying for an ARM

Consumers who are interested in purchasing a home that they will own for only a few years, planning to sell well before the mortgage is paid in full, would be smart to consider an adjustable rate mortgage. Consumers who intend to stay in their home for decades should consider something a bit more stable. Those who are just starting out in their careers and expect to generate significantly higher income in three to five years would be wise to consider an ARM if they want to purchase a larger or more expensive home than they would otherwise be able to afford. The final thing to consider with an adjustable rate mortgage is what other types of debt the consumer will incur while paying their mortgage. This is important to consider because as payment amount can drastically vary with the mortgage, it may cause a financial hardship while other debts are being repaid as well.

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