An ARM, Adjustable Rate Mortgage is a loan where the rate will adjust, typically up to twice a year based on a Margin and Index. The index is something independent and public like Treasury Notes or the LIBOR (London Interbank Offered Rate) and these are published daily. The margin is how much higher or lower your rate will be.
Initially your rate may be fixed for a period of time, 6 months, 2 years, 5 years, 7 years and 10 years are most common. The shorter the fixed period the lower the rate usually starts. Once you reach the change date your remaining payments will be adjusted to the new rate to keep you paying on schedule for a 0 balance at the end of the loan.
The benefit of an ARM is the low rate you get locked in for the fixed period. If you know you will be selling in 5 years, a 5/1 ARM may be a good option for you, if you are sure.
The risks are what will happen when things change. Most ARMâ€™s will have a 2 point annual maximum change and a 5 point lifetime change. This means that if you start at 3% your maximum rate would not exceed 8%. Sometimes the first adjustment can be more than the 2% annual cap, but you would stay at the annual cap after that.
My numbers are examples and based on my past experience as a lender. There may be changes to these programs and you will need to review any terms you are offered very carefully. Many people bad mouth these loans, but like any tool, if properly understood and applied can be a good option for many.