How do ARMs work?

ARM is short for Adjustable Rate Mortgage, and it means that the interest rate on your mortgage will fluctuate to reflect current market rates.

Most ARMs have an "introductory rate" that's fixed for a specified number of months or years. This rate is often very low, and can last for the first five to ten years of the loan. Unfortunately, many people get lured into an ARM because of the low front-end rate, only to be shocked when the rate jumps dramatically at the end of the fixed rate period. That's why it's important to find an ARM with a rate adjustment cap.

A rate adjustment cap controls the increase of your loan's interest rate over a given period. For example, let's say you have a fixed rate of 5% for the first five years, and during that time market rates increase by 4%. If you don't have a rate adjustment cap, the interest rate immediately increases to 9%, and your monthly payments increase significantly. A 1% adjustment cap, however, will limit the increase to 1% a year over the next four years.

If you're considering an ARM, we recommend finding out some specific information before making a final decision:

  1. How long does the fixed rate last?
  2. How much can the rate jump at the end of the fixed rate period?
  3. Is there a rate adjustment cap? And if so, what is it?

Answers to these questions will prevent surprises and potential financial challenges.