Adjustable-Rate Mortgage (ARM)

  

Categories: Metrics, Tax, Bonds, Real Estate

The key letter in ARM is A, and it stands for adjustable, as in Adjustable Rate Mortgage.

Most mortgages have a fixed interest rate. That means you pay 5% interest (or whatever your rate is) during the first year you have your mortgage, during the third year, and all the way to the final day you have that loan and can throw your big ""We Paid it Off"" party.

With an adjustable rate mortgage, your rate can change. Why would you want to get an ARM rather than a fixed rate mortgage? Well, maybe you like the element of surprise. More likely, you can save a few bucks at the start of the mortgage loan. If interest rates are expected to rise, you can get a better rate (at first) with an ARM than you can with a fixed rate mortgage. By the time your ARM rates go up and you have to pay more, maybe you'll have gotten that promotion at work.

Lots of folks choose ARMs, because they seem like a better deal on paper, but you'll want to run side-by-side comparisons to figure out whether they'll cost you more in the long run. You'll also want to make sure you can afford your home loan—even if interest rates go up. If you're just barely making payments now and your monthly mortgage costs go up $300, what are going to do? That's the sort of situation that causes people to lose their homes.

ARMs have a couple parts. They usually start with a low interest rate and have a guaranteed period of time for that interest rate, so you know your interest rate won't go up right away. An ARM also usually comes with an index (like LIBOR) against which it is adjusted, a step up percentage (how much the interest rate will likely grow each period), and maybe a cap (the maximum rate it can be raised in a given period). That all ensures that the rate won't balloon out of control.

Some ARMs are interest-only for the first few years. The monthly amount you pay is really low, but you're also not paying down the principal or the amount you borrowed. Which means the total amount you owe to the bank is not going down any. The upside is that your payments will be affordable at first, and you'll have time to increase your income or get a great job (and hopefully give interest rates a chance to drop).

Related or Semi-related Video

Finance: What is Adjustable-Rate Mortgag...17 Views

00:00

Finance allah shmoop What is adjustable rate mortgage or arm

00:08

Well here's an arm and here's a leg and that's

00:11

What Renting the money to buy a home costs you

00:14

Yeah Okay Eight r m stands for adjustable rate mortgage

00:17

The rate well that's The interest cost of the money

00:20

or the cost of renting that money to buy the

00:23

home Well the rate isn't it fixed in this case

00:26

like five point seven percent for thirty years Where you

00:28

know in advance that your monthly payments going to be

00:31

nine hundred forty three bucks a month or whatever it

00:33

is that would be a fixed mortgage a fixed number

00:37

You can count on it for all three hundred sixty

00:40

payments And then the house is all yours So that's

00:43

fixed then what's adjustable like yes the interest rate changes

00:47

But how does it change Well in a standard arm

00:50

there is some global standard on which the rates are

00:53

often price like lie bore the london interbank borrowing offering

00:57

rate It's one of the key things that price is

00:59

the cost of renting money all around the world with

01:02

the actual rate of libel or is generally reserved for

01:04

banks like super cheap cost of renting money to banks

01:08

who are very likely to pay back the money with

01:11

no hassle that rate is more or less what banks

01:14

pay for running the money along with blue chip customers

01:16

in real life The banks then mark up a premium

01:19

on top of the rate that they're paying to rent

01:22

the money to themselves And then they resell or re

01:26

rent that money teo their prized customers So the pricing

01:30

of bank my views in renting money to joe six

01:33

pack could be something like lie boer plus three percent

01:37

or three hundred basis points So if libel or is

01:40

it didn't say two and a half percent today the

01:43

adjustable rate might be five and a half percent and

01:46

all that's great honor given alone It might mean that

01:48

for a while you're paying seven hundred twelve dollars a

01:51

month for your house payment wonderfully cheap and in fact

01:54

banks market these low rates initially to help people be

01:58

able to afford tto by that new home and live

02:00

of the dream You know the american dream usually with

02:03

an arm there's a teaser rate that starts really low

02:07

Like at live or live or plus ten basis points

02:11

or something like ridiculously cheap for six months or a

02:14

year something like that Then it has an incremental set

02:17

of step ups in interest costs and venit adjust with

02:21

the markets usually upward maybe upward by a lot Remember

02:26

there's a reason it's called a teaser rate but then

02:29

if we get inflation or a you know just bank

02:32

nervousness for there are weird effects from brexit or the

02:35

volume of transactions going through london or something weird happens

02:39

Well then the liquidity drops and interest rates rise So

02:44

now lie board goes up and up and up to

02:46

four and a half percent and wealth contractually in your

02:50

mortgage paperwork you have to pay live or plus three

02:53

hundred basis points no matter what So now that's seven

02:56

and a half percent interest on the dough you borrowed

03:00

and well we're that toe happen It's likely that your

03:02

monthly payment has skyrocketed from seven hundred twelve dollars a

03:06

month is something more like twelve hundred dollars a month

03:09

or more Can you handle that big of a payment

03:11

Well have you done a fixed rate loan at nine

03:13

Hundred forty three dollars a month Well you'd still be

03:15

paying on that number but you rolled the dice with

03:18

an arm and now you owe big bills There go

03:22

that arm and a leg thing we warned you about 00:03:26.033 --> [endTime] eh

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