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Understanding Adjustable Rate Mortgages


Adjustable Rate Mortgage written on a notebook cover

Choosing the right mortgage can be as crucial to your financial health as selecting the right home is to your personal happiness. For many, an Adjustable Rate Mortgage (ARM) offers a blend of affordability and adaptability that fits their needs perfectly. But how do these types of mortgages work, especially when it comes to understanding the monthly payment process?

An ARM differs from a fixed-rate mortgage in that the interest rate attached to the loan can fluctuate throughout the life of the loan based on an index of treasury bonds. Initially, ARMs offer a lower interest rate compared to fixed-rate mortgages, making them particularly attractive for borrowers seeking lower initial payments. However, it's vital to understand that your monthly payments can change over time.

The monthly payment process of an ARM begins with a fixed interest rate period, which typically lasts for 3, 5, 7, or 10 years. During this phase, your interest rate—and consequently your monthly payments—remain stable and predictable. After this initial period concludes, the interest rate adjusts at a predetermined frequency, such as annually, based on a specific financial index plus a margin.

When the adjustment period kicks in, your monthly payments can either increase or decrease, depending on the direction of interest rate movements. This mechanism is what makes ARMs less predictable in the long term but can potentially save you money in interest payments if interest rates decline.

A notable variant of ARMs is the 5/5 ARM, which offers a unique blend of predictability and flexibility. Unlike traditional ARMs that might adjust annually after the initial fixed period, the 5/5 ARM adjusts only once every five years. This means if you start with an initial fixed interest rate period of 5 years, your rate would then adjust at the start of the 6th year and would not change again until the 11th year, and so on.

This can be particularly attractive for borrowers looking for lower rates than a 30-year fixed mortgage but are concerned about frequent rate changes. It provides a middle ground, offering more stability than the standard ARM while still allowing for potential savings if interest rates decrease over time.

To provide some protection against dramatic swings in payments, most ARMs feature caps that limit how much the interest rate or the monthly payment can increase in a single adjustment period as well as over the life of the loan. Understanding these caps is crucial because they dictate the potential fluctuation of your monthly payments.

ARMs can help first-time homebuyers afford a new home, especially with rising fixed interest rates and the ever-increasing burden of rent. However, careful consideration of your financial goals, risk tolerance, and long-term plans is essential. Consulting with a qualified mortgage consultant can help you understand your options and choose the loan that best suits your situation.

An option for first time homebuyers to consider, SCU Credit Union offers a 5/5 Adjustable Rate Mortgage. If you’d like more information, you can stop in at one of our branch locations for assistance or reach out to our member service call center at 781-784-7725 or toll free at 1-877-661-3300.

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