Adjustable-Rate Mortgage: What Is It & How Does It Work?

Learn how an Adjustable-Rate Mortgage works, what makes it different from a fixed-rate mortgage, and when it could be a smart choice for your financial goals.

If you’re exploring home financing options, you’ve likely come across an Adjustable-Rate Mortgage (ARM). But what exactly is it – and how does it compare to a traditional fixed-rate mortgage?

Let’s break down how ARMs work, the pros and cons, and when it might make sense to choose one.

What’s An Adjustable-Rate Mortgage?

An Adjustable-Rate Mortgage (ARM) is a type of home loan with an interest rate that fluctuates over time. Unlike a fixed-rate mortgage, which has the same interest rate for the life of the loan, an ARM starts with a fixed interest rate for a set period – usually 3, 5, 7, or 10 years – before switching to a variable rate that adjusts periodically.

After the fixed-rate period ends, the interest rate is adjusted based on a formula set by the lender, which typically includes a market-based index and an additional margin. This means that your monthly payments may go up or down over the remaining term of the loan.

How Do They Work?

ARMs begin with a fixed interest rate for a set number of years, followed by periodic adjustments. The two numbers in the loan type describe the structure of the rate.

Let’s look at two options offered at A+FCU:

• A 5/5 ARM has a fixed rate for the first 5 years, then adjusts once every 5 years.
• A 10/10 ARM has a fixed rate for the first 10 years, followed by rate adjustments every 10 years.

Once the fixed-rate period ends, the interest rate can go up or down based on market factors.

To help protect you, most ARMs come with rate caps, which limit how much your rate can increase each time it adjusts and over the life of the loan.

In short, ARMs offer a lower starting rate with the possibility of changes later, making them a smart option if you don’t plan to stay in your home for the long term or expect interest rates to stay low.

ARMs vs. Fixed-Rate Mortgages

As you can see, while both an ARM and a Fixed-Rate Mortgage help you finance a home, they work differently, and choosing which is right for you depends on your financial goals and how long you plan to stay in the home.

Key Differences

What They Have In Common

 Both loan types:

• Require a credit check, down payment, and an approval process
• Allow you to borrow money to purchase or refinance a home
• Offer various loan term options – like 15, 20, and 30 years
• May come with closing costs and other fees

Pros & Cons Of An ARM

Like any loan, Adjustable-Rate Mortgages come with advantages and potential drawbacks. Understanding both sides can help you decide if an ARM fits your financial situation and future plans.

Pros

• Lower starting rate: ARMs usually offer lower interest rates during the initial fixed period, which can help reduce your monthly payments early on.
• Potential interest savings: If market rates stay low or decrease, your payments could remain manageable or even go down after the fixed period.
• Short-term flexibility: Ideal for buyers who plan to move, refinance, or pay off the loan before the rate starts adjusting.

Cons

• Unpredictable payments: Once the fixed period ends, your rate can rise – meaning higher monthly payments.
• More complex terms: ARMs involve indexes, margins, and rate caps, which can be confusing to navigate.
• Potential for higher costs: If market rates rise significantly, you could end up paying more in the long run.

While ARMs can offer meaningful savings upfront, it’s important to weigh those benefits against the risk of future rate increases, especially if you plan to stay in your home for many years.

When To Consider An ARM

An ARM can be a smart choice depending on your financial goals and how long you plan to stay in your home. For example, if you know you’ll be moving or refinancing before the fixed-rate period ends, an ARM may offer significant savings thanks to its lower initial rate. This makes it a good option for people who don’t plan to keep the loan long-term.

It can also be helpful if you’re looking for lower monthly payments upfront to manage short-term expenses or invest money elsewhere. And if you believe interest rates will remain steady – or even drop – over the coming years, you might benefit from smaller adjustments or lower payments down the line.

However, it’s important to feel comfortable with the possibility that your rate and payment could increase after the fixed period. If you prefer a more predictable monthly budget or plan to stay in your home long-term, you may want to consider a Fixed-Rate Mortgage instead.

Why Choose A+FCU For An Adjustable-Rate Mortgage?

Whether you’re just starting to explore home financing options or you’re seriously considering an Adjustable-Rate Mortgage, A+FCU is here to help. Our team of mortgage experts can guide you through the process, explain your options clearly, and help you decide if an ARM is right for you.

With competitive rates, personalized support, and a focus on your long-term financial success, A+FCU can help make your home financing journey smoother.

Still have questions or need help deciding if an ARM is right for you? Take the first step – contact A+FCU today to have our dedicated lending team assist you.