Adjustable-rate mortgages, or ARMs, aren’t for everyone because of their complexity, but they can be a strategic option. Initially, the interest rate and monthly payment on an ARM loan is smaller than that of a fixed-rate mortgage. The lower ARM payment can allow home buyers more cash flow during the early years of ownership, freeing up funds for home renovations or other needs.

The catch: after the ARM introductory period, which is usually between 1 to 5 years, the interest rate adjusts periodically, according to the market index assigned to the loan.

Many ARM loans use LIBOR as a market index – sort of an international version of the Federal Reserve’s benchmark rate. COFI is another market index that may be used. The index that applies to your loan would be disclosed in your loan documentation.

In other words, future economic conditions, and the prevailing cost of money, control the direction of your ARM interest rate. ARM loans are a gamble. If rates go up, so will your mortgage payment!

Even if rates head lower, it’s no guarantee that your future payments wouldn’t be higher anyway. This is because a margin is added to the index to calculate your new interest rate. So, if your index falls a bit, but then a 2% margin is added, odds your new payment could still be higher than the original.

The margin is determined by your lender at the time of your ARM application. Buyers who are considering an ARM loan must pay close attention to the margin being set!

Now, some good news. Most ARMs have rate caps that limit how high your interest rate can go. Here’s how the Consumer Financial Protection Bureau explains them:

Initial adjustment cap. This cap says how much the interest rate can increase the first time it adjusts after the introductory, fixed-rate period expires. It’s common for this cap to be either 2% or 5%. This means the first rate change can’t be more than 2 or 5 percentage points higher than the initial rate.

Subsequent adjustment cap. This cap says how much the interest rate can increase in the adjustment periods that follow. This cap is most commonly 2%, meaning that the new rate can’t be more than two percentage points higher than the previous rate.

Lifetime adjustment cap. This cap says how much the interest rate can increase in total, over the life of the loan. This cap is most commonly 5%, meaning that the rate can never be more than five percentage points higher than the initial rate. (Some lenders may have a higher cap.)

ARM’s work best for home buyers who intend to occupy the property for a few years until they relocate, trade up, or sell for a profit (hopefully) after making renovations. Home buyers who are putting down roots could be better served by a fixed-rate mortgage, especially as today’s interest rates remain very reasonable.

The best decisions are made when you have good information and expert advice! As your Exclusive Buyer Broker, we will refer you to trustworthy, local lenders who will explain all of your options. And because we provide our Buyer-Clients fiduciary representation, we can help you review your mortgage offers!

As your Exclusive Buyer’s Broker, we serve your best interests at all times! Unlike real estate agents and brokerages who represent sellers, as an Exclusive Buyer’s Broker, we only represent you, the buyer, getting you the best price and terms with no conflict of interest.

Understanding this distinction could literally save you thousands of dollars not only on the purchase price and terms, but also on seller concessions and home inspection issues, whether you are a first-time homebuyer or an experienced homeowner!

Contact us with your home buying questions! Remember, we are with you every step of the way…all the way home!

Andrew Show
Broker, CEBA, CEBA-M, CNE, CSP, ABR-M, e-PRO, GREEN
Buyer’s Resource Realty Services
Serving Metro Columbus, Ohio with Exclusive Buyer’s Agents
7100 North High Street, Suite 204, Worthington, Ohio 43085
614-888-4110 | 888-888-4110 Toll Free | 614-839-4110 Fax

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