ARM loan rates

Adjustable-rate loans are usually best for borrowers who plan to move before the fixed period ends, or are prepared to refinance once the loan starts adjusting.

Since ARMs typically offer a low interest rate during the initial fixed stage, they can seem attractive in a rising-rate environment. That said, there’s a risk that payments may become burdensome once the rate adjustments start.

Most ARMs take 30 years to fully amortize, so you could be stuck with up to 25 years of variable payments if you stay put and don’t refinance to a fixed loan.

>>Read more about choosing between an ARM and a fixed-rate mortgage.

It all comes down to your personal financial goals. Compared to 30-year fixed-rate mortgages, ARMs typically have lower introductory rates. If you plan to sell your home, pay off the loan or refinance before the fixed-portion of the ARM expires, you might save significantly with an ARM.

If you’re comparing ARM rates to shorter-term fixed-rate options, you might find that those rates are about the same. The difference is that with ARMs you can spread the payment over 30 years, so you can get a low rate (on par with a 10-year fixed-rate mortgage) without the high monthly costs. In this scenario, an ARM might be a smart move if you don’t plan to stay in the house long-term or plan to refinance before the fixed period ends.

A rate cap puts a limit on how much your interest rate can go up. There are two types of caps:

• Period adjustment cap: How much your rate can go up or down within an adjustment period
• Lifetime cap: Limits rate increase throughout the lifetime of the loan (by law ARMs must have a lifetime cap)

Be aware that your monthly payments won’t necessarily go down (or up) right away if there is a drop in interest rates. Some lenders may hold on to some or all of the rate decline and move it over to the next adjustment period — referred to as a carryover.

For example, if your rate cap is 1 percentage point and interest rates went up by 2 percent, your lender can hold onto the “extra” 1 percent and increase your monthly payment in the future even if the index rate hasn’t gone up.

ARM loans have a few requirements which are similar to other types of mortgages.

Loan amount: In 2022, homebuyers can borrow up to $647,200 for a conforming ARM (limits may be higher in areas with higher home prices). You can take on a jumbo ARM which exceeds the conforming loan limit, though both these types of loans can be harder to secure.

Credit history: With a higher credit score, you’re more likely to be approved for a competitive interest rate. Lenders will also look at other factors such as other debt and income.

Down payment: It’s ideal to put down a 20 percent down payment so you can avoid PMI (private mortgage insurance), which adds to your monthly mortgage payment. However, most conventional ARM loans allow as little as 5 percent down (with PMI), and government-backed loans such as FHA and VA loans have even lower (or no) requirements.

The most common types of ARMs are also known as hybrid ARMs. These have initial fixed-rate periods followed by a floating rate for the remainder of the loan. Hybrid ARMs include:

• 3/1 ARM: The first three years have a fixed rate followed by a floating rate for the remainder of the loan.
• 5/1 ARM: The first five years have a fixed rate followed by a floating rate for the remainder of the loan.
• 7/1 ARM: The first seven years have a fixed rate followed by a floating rate for the remainder of the loan.
• 10/1 ARM: The first 10 years have a fixed rate followed by a floating rate for the remainder of the loan.

Usually, 5/1 ARMs have the lowest interest rate of the bunch. For those who think they’ll refinance or sell within five years, this could be a cost-effective mortgage option.

Of course, it’s also a gamble. If your income or credit situation changes for the worse, you might not be able to refinance. If you can refinance, you might end up with a higher rate than if you would have gotten a fixed-rate loan in the first place.

There are also VA and FHA ARMs which are basically the same loans, with the same qualifications and requirements as their fixed-rate counterparts, but with an adjustable rate.

If you know that you won’t keep the home longer than the initial period, you could end up saving money. If you stay with an ARM past the fixed-rate period, you run the risk of your rate rising (it could also fall if rates drop).