what is an adjustable rate mortgage arm 
the term adjustable rate mortgage arm refers to a home loan with a variable interest rate with an arm the initial interest rate is fixed for a period of time after that the interest rate applied on the outstanding balance resets periodically at yearly or even monthly intervals arms are also called variable rate mortgages or floating mortgages the interest rate for arms is reset based on a benchmark or index plus an additional spread called an arm margin the london interbank offered rate libor was the typical index used in arms until october 2020 when it was replaced by the secured overnight financing rate sofr in an effort to increase long term liquidity understanding adjustable rate mortgages arms mortgages allow homeowners to finance the purchase of a home or other piece of property when you get a mortgage you ll need to repay the borrowed sum over a set number of years as well as pay the lender something extra to compensate them for their troubles and the likelihood that inflation will erode the value of the balance by the time the funds are reimbursed in most cases you can choose the type of mortgage loan that best suits your needs a fixed rate mortgage comes with a fixed interest rate for the entirety of the loan as such your payments remain the same an arm where the rate fluctuates based on market conditions this means that you benefit from falling rates and also run the risk if rates increase there are two different periods to an arm one is the fixed period and the other is the adjusted period here s how the two differ another key characteristic of arms is whether they are conforming or nonconforming loans conforming loans are those that meet the standards of government sponsored enterprises gses like fannie mae and freddie mac they are packaged and sold off on the secondary market to investors nonconforming loans on the other hand aren t up to the standards of these entities and aren t sold as investments rates are capped on arms this means that there are limits on the highest possible rate a borrower must pay keep in mind though that your credit score plays an important role in determining how much you ll pay so the better your score the lower your rate the initial borrowing costs of an arm are fixed at a lower rate than what you d be offered on a comparable fixed rate mortgage but after that point the interest rate that affects your monthly payments could move higher or lower depending on the state of the economy and the general cost of borrowing types of armsarms generally come in three forms hybrid interest only io and payment option here s a quick breakdown of each hybrid arms offer a mix of a fixed and adjustable rate period with this type of loan the interest rate will be fixed at the beginning and then begin to float at a predetermined time 2this information is typically expressed in two numbers in most cases the first number indicates the length of time that the fixed rate is applied to the loan while the second refers to the duration or adjustment frequency of the variable rate 2for example a 2 28 arm features a fixed rate for two years followed by a floating rate for the remaining 28 years in comparison a 5 1 arm has a fixed rate for the first five years followed by a variable rate that adjusts every year as indicated by the number one after the slash likewise a 5 5 arm would start with a fixed rate for five years and then adjust every five years 2you can compare different types of arms using a mortgage calculator it s also possible to secure an interest only i o arm which essentially would mean only paying interest on the mortgage for a specific time frame typically three to 10 years once this period expires you are then required to pay both interest and the principal on the loan 3these types of plans appeal to those keen to spend less on their mortgage in the first few years so that they can free up funds for something else such as purchasing furniture for their new home of course this advantage comes at a cost the longer the i o period the higher your payments will be when it ends 3a payment option arm is as the name implies an arm with several payment options these options typically include payments covering principal and interest paying down just the interest or paying a minimum amount that does not even cover the interest 4opting to pay the minimum amount or just the interest might sound appealing however it s worth remembering that you will have to pay the lender back everything by the date specified in the contract and that interest charges are higher when the principal isn t getting paid off if you persist with paying off little then you ll find your debt keeps growing perhaps to unmanageable levels 4advantages and disadvantages of armsadjustable rate mortgages come with many benefits and drawbacks we ve listed some of the most common ones below the most obvious advantage is that a low rate especially the intro or teaser rate will save you money not only will your monthly payment be lower than most traditional fixed rate mortgages but you may also be able to put more down toward your principal balance just ensure your lender doesn t charge you a prepayment fee if you do arms are great for people who want to finance a short term purchase such as a starter home or you may want to borrow using an arm to finance the purchase of a home that you intend to flip this allows you to pay lower monthly payments until you decide to sell again more money in your pocket with an arm also means you have more in your pocket to put toward savings or other goals such as a vacation or a new car unlike fixed rate borrowers you won t have to make a trip to the bank or your lender to refinance when interest rates drop that s because you re probably already getting the best deal available one of the major cons of arms is that the interest rate will change this means that if market conditions lead to a rate hike you ll end up spending more on your monthly mortgage payment and that can put a dent in your monthly budget arms may offer you flexibility but they don t provide you with any predictability as fixed rate loans do borrowers with fixed rate loans know what their payments will be throughout the life of the loan because the interest rate never changes but because the rate changes with arms you ll have to keep juggling your budget with every rate change these mortgages can often be very complicated to understand even for the most seasoned borrower there are various features that come with these loans that you should be aware of before you sign your mortgage contracts such as caps indexes and margins saves you moneyideal for short term borrowinglets you put money aside for other goalsno need to refinancepayments may increase due to rate hikesnot as predictable as fixed rate mortgagescomplicated