An adjustable rate mortgage (ARM) is a mortgage for a fixed, longer term, but including an interest rate that adjusts (changes) during the life of the loan. These kinds of mortgages became popular among lenders when interest rates were increasing rapidly and banks were lending at fixed rates for 25 or 30 years.
For a long time, interest rates were fairly steady and lenders had no problem setting a rate on a mortgage because their cost of funds remained fairly stable.
Even though ARMS are not traditional mortgages, with thirty year terms, they can still have terms as long as that. Most borrowers don’t actually concern themselves with the term of an ARM, but rather how frequently the rate “resets”. If you think you will be in your home for a long time, you should try to get the longest fixed rate period you can.
Most of the time, the five year adjustment period is what works for most borrowers. If the ARM rate adjusts more frequently, you will be exposed to additional costs. If your ARM is at 6% for five years, for example, it will not go up, even if rates go up to 8%, then back down to 7%.
Those who had an ARM that adjusted each year would have had to take each of the increases on the road to 8%. Luckily, many ARMs have some kind of top interest rate cap as a part of the agreement.
One of the most important factors in the ARM you choose is how long you plan on staying in your home. If you only plan on being in it for a few years, your main concern will be what the initial rate on the ARM is. However, those who normally live in their homes for longer periods will want the longer adjustment periods. Normally you cannot get an adjustment period of more than 7 years.
You also have to know which benchmark is being used to set the rate: government bonds, the LIBOR, CDs or others. Depending upon your view on interest rates, each one has its benefits. Be aware that any ARM with a frequent adjustment period will affect your mortgage payment frequently.
This is not an ideal situation for many homeowners, who have to live on a set budget.
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