Adjustable Rate Mortgage Tips

An adjustable rate mortgage, often known as simply as an ARM, is a loan product that allows a borrower to determine monthly repayments based on changing interest rates. Whereas with a fixed loan, or conventional loan, a borrower “locks in” to a specific interest rate and pays that rate for the life of the loan unless he or she decide to refinance, with an adjustable rate mortgage, the borrower is in a sense at the whim of the national housing rates.

A pure adjustable rate mortgage gets adjusted over a fixed increment of time -- six months is a common increment here. Many American homeowners opt for what is known as hybrid ARMs.

This arrangement is a cross between a fixed rate and an ARM. For instance, in the common 2/28 ARM product, a borrower will pay a fixed introductory rate for the first two years of a 30-year mortgage and then pay at the national housing rate for the next 28 years.

Adjustable Rate Mortgage - Will it work for you?

ARMs aren't for everybody. They are ideal for young families with burgeoning income potential. Since the rates for these mortgages are usually lower (during the first few years), borrowers can use these years to invest in their careers and generate financial vehicles to manage risk down the line. Homeowners who are looking for short-term purchases also enjoy the adjustable rate mortgage option.

To protect yourself against the risks of volatile rate performance, you can request certain caps be included in your contract with your lender. For instance, you may stipulate that the interest rate on your mortgage can't go up by more than a certain percentage during a calendar year, even if the national housing rate exceeds that percentage. You can also state in writing that the rate can't go above a given rate at anytime of the life the loan.

To protect yourself against the shock of suddenly highly mortgage payments, it may be smart to budget in a cushion. You can track trends in your area and look at an overall forecast for the national housing rate to determine what kind of adjustable rate mortgage suits your risk profile. Work with your accountant and spouse to create a reserve of cash to handle mortgage payments that may occur if rates spike, and consider refinancing if rates drop to propitious levels.