If you are exploring mortgage options, you may also come across an adjustable mortgage in the term “arm loan” or “arm mortgage”. But what exactly is an adjustable mortgage? How does it work? Whether you’re browsing a home for sale in Denver, Colorado, or planning on making an offer at a home in Miami, Florida, knowing how the arms work can help you choose the financing option that best suits your needs.
This Redfin guide explains what adjustable mortgages are, how they work, the different types available, their advantages and disadvantages, and who they are suitable for.
What is an adjustable mortgage?
An adjustable mortgage (ARM) is a type of mortgage where interest rates can change over time. Unlike fixed-rate mortgages that maintain the same interest rate across periods, ARM mortgages usually start with low introductory interest rates that are adjusted regularly based on market conditions.
Adjustable mortgage mechanism
Arm Loans have two phases.
Initial fixed interest rate period: This is usually 3, 5, 7, or 10 years, during which the interest rate is fixed, usually lower than a fixed interest mortgage. Adjustment Period: After the fixed period ends, interest rates can be adjusted annually (or more often) based on fixed margins set by lenders, based on indexes (such as SOFR or Treasury indexes).
Arm Loans and Fixed-Rate Home Loans
Baseline ARM Loan Fixed Rate Mortgage Interest rates begin low and remain the same for the full period after adjustment.
Adjustable mortgage types
Arm loans come in a variety of structures, often identified by two numbers (such as 5/1 or 7/6) that explain the frequency at which fixed periods and rates are adjusted later. Understanding weapon types can help you choose the one that suits your financial goals. Common arm types:
3/1 Arm: Fixed interest rate for the first 3 years, then adjusted once a year. 5/1 Arm: Fixed rate for 5 years, adjusted every year thereafter. One of the most popular options. 7/1 ARM: Fixed rate for 7 years, adjusted every year thereafter. It is often chosen by buyers who plan to stay longer before selling or refinancing. 10/1 Arm: Fixed rate for 10 years, adjusted every year thereafter. It provides the longest fixed period, but usually provides a slightly higher initial speed than the shorter arm. 5/6 or 7/6 arm: Fixed rate for the first period (5 or 7 years), then adjust every 6 months rather than once a year.
Tip: When comparing arm types, pay close attention to the index, margin and rate cap. These factors determine how often the rate changes after a fixed period.
Key features of arm loans
Feature Description The adoption rate limits how much the rate can rise with each adjustment or lifetime of the loan index market benchmark with a lower adjustment cap than a fixed-rate mortgage.
How to qualify for an adjustable mortgage
Eligibility for an adjustable mortgage is similar to qualifying for a fixed-rate loan, but lenders may have specific requirements to allow them to handle potential rate increases. The general requirements are:
Credit Score: Many lenders prefer scores of at least 620-640, but the higher the score, the lower the introductory rate. Debt Income (DTI) Ratio: Usually below 43%, indicating that you can manage your monthly payments even when your fees increase. Stable Income: Lenders will check their payroll stubs, W-2s, or tax returns to ensure consistent earnings. Down payment: Lowest lower payments vary, but in many cases it is 5%-10% for traditional weapons. Adequate reserves: Some lenders need cash reserves to cover mortgage payments for a certain number of months.
Tip: Because arm rates can increase, lenders can use a “qualified rate” (higher than the initial rate) to ensure that they can still make payments after adjustments.
Adjustable mortgage refinance
Adjustable mortgage refinancing can be a wise move, especially before the end of a fixed-rate period or if interest rates drop. Refinance allows you to switch to a fixed-rate mortgage for predictable payments or refinance into a new sector if market conditions are favorable. When to consider refinancing:
Before the first adjustment: Locking at a fixed rate before the arm reset will protect you from potential increases in payments. If your rates are low: Refinancing in a low-cost environment can help you save money over the lifespan of your loan. If your finances change: Improved credit, higher income, or reduced debt may qualify for better rates and terms.
>>Read: Should I refinance my mortgage?
Pros and cons of adjustable mortgages
Strong Points:
Reducing initial payments: Perfect for short-term homeowners and those who are expected to earn an income. Possibility of a decline in long-term interest rates: If interest rates drop, interest rates (and payments) may decrease. Affordable prices: Lower future costs will help buyers qualify for more expensive homes.
Cons:
Rate uncertainty: Payments can increase significantly after a fixed period. Refinance risk: If the fee is too high, you may need to refinance. Complexity: Arm terms, indexes, and caps can be confusing.
Who should consider arm loans?
An adjustable mortgage may be suitable if you are.
Plans to sell or refinance before the initial fixed interest period ends. You expect your income to increase in the next few years. Early monthly payments will be lower to improve cash flow in the short term.
>>Read: How to get the best mortgage rate
Adjustable mortgage FAQ
1. Do arm loans always go up?
That’s not necessarily the case. Arms interest rates are associated with market indexes and can rise or fall depending on the economic situation. However, many borrowers will increase once the adjustment period begins, especially if the fees have risen since the loan has arisen.
2. Can I refinance my arm loan?
yes. Many homeowners refinance for fixed-rate mortgages before the adjustment period begins to lock at a more stable rate.
3. What is a rate cap?
The rate cap limits how much interest rates can rise during adjustments. There are usually three types.
Initial Cap: Limiting First Adjustment Cycle Cap: Limiting Subsequent Adjustment Lifetime Cap: Maximum Rate can increase over the life of the loan
Final Thought: Is an adjustable mortgage right for you?
Arm loans offer lower initial fees. This could be a wise financial move with certain buyers, especially short-term homeowner plans and expectations for rate declines. However, due to the risk of rising payments, it is important to carefully evaluate financial stability, market trends and long-term plans.
Always compare your options and talk to your mortgage lender to find the right one for your situation.
