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| ARM: Adjustable Rate Mortgages |
Adjustable Rate Mortgages, or ARM loans, available as 10/1, 7/1, 3/1 ARM programs and also available as 1 month, 6 month, or 1 Year loans, have a lower initial monthly payment than Fixed Rate Mortgages, and also have a lower payment over a shorter period of time. Rates and payments may go down if rates improve, and you may in time qualify for higher loan amounts. However, ARM loans are more risky, with the payments changing over time, and there is a potential for high payments if the rates go up.
In an ARM, the interest rate is fixed for a period of time, after which it will periodically (annually or monthly) adjust up or down to some market index. Common indices in the U.S. include the Prime Rate, the London Interbank Offered Rate (LIBOR), and the Treasury Index ("T-Bill"). Other indexes like 11th District Cost of Funds Index, COSI, and MTA, are also available but are less popular.
Adjustable rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where unpredictable interest rates make fixed rate loans difficult to obtain. Since the risk is transferred, lenders will usually make the initial interest rate of the ARM's note anywhere from 0.5% to 2% lower than the average 30-year fixed rate.
In most scenarios, the savings from an ARM outweigh its risks, making them an attractive option for people who are planning to keep a mortgage for ten years or less.
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