Popular Types of Adjustable Rate Mortgages

Mortgage loans are a very big business. The vast majority of potential consumers engage in a loan when they purchase a home. Very few of us are able to pay for the entire amount of the house without assistance. The conventional mortgage is the most popular and most widely understood financial agreement. The borrower agrees to pay the lender the same amount on a monthly basis for the entirety of the loan. There are no surprises. Once it is paid off, the house is the consumers. This is the most popular type of mortgage loan.

However, there are plenty of alternatives for those of you who desire something different. Many of us don't plan on being in the same home for 15-30 years and it's not one size fits all. Plus a vast majority of us will make more money as we dive further into our careers. These alternatives are known as adjustable rate mortgages. They are not for everyone, but they do have value for many. Here are some adjustable rate mortgages or ARM's that might be perfect for you.

There are a few terms that you will need to be familiar with when you see the terminology for an ARM mortgage. Remember that the only real reason to do one of these types of loans is because the initial interest rate is cheaper than any conventional brother you can find. This might allow you to move into a home that you couldn't afford otherwise. But for many, they know that they will be making more money later in their career, and this may make sense.

Caps: each mortgage has a limit on how much it can reset each period and over the life of the loan. The reason that CAPs exist to prevent outrageous rates that many homeowners cannot pay.

It's a good time to point out that leasing a space is never a bad idea. The costs are much cheaper upfront and you won't have to pay for repairs and property taxes.

Index: All of these are tied to a broader index that will determine how much your payment goes up or down. You will want to read your agreement to see which index your mortgage follows.

The 5/25 ARM

This ARM is pretty simple to understand. Your initial interest rate is fixed for 5 years. This means you pay the same amount for 60 months. Now starting the 6th year the rate can and usually will reset. But after it resets, this will be your fixed payment for the next 25 years. This type of mortgage is best for those you can tolerate one rate change during the lifetime of the loan.

The 5/1 ARM

Probably one of the most popular ARM to consider is the 5/1. Again the first 5 means that your interest rate is fixed for the first 60 months. So starting year 6 your rate will reset, and each year thereafter. This is the type of ARM that could potentially keep you up at night. So year 7, 8, 9, and so on will also be reset according to the mortgage index. There will be CAPS though that limit how much the rate can go up each period. If rates move down, so will your payment.

Here is a cool ARM calculator you can use to check rates.

The 3/3 Mortgage

Not the most popular type of mortgage, but one that gets its fair share of attention is the 3/3.
The initial teaser period is for 3 years. At the start of the 4th year the rate will reset. This new rate will remain constant for year 4, 5, and 6. Then the rate will reset again on year 7. This goes on until the loan is satisfied or the house is paid off.

The main advantage to the 3/3 is that rates can only be reset every 3 years. So if rates were to spike during the end of year 4, you wouldn't feel any increases for year 5 or 6. But starting year 7 it's possible and highly likely you get an increase.

10/1 Mortgage

The 10/1 stays fixed for 10 years. This is quite a bit of time and offers several advantages. For one, if you don't plan on being in your home for more than 10 years then you can sell your home before the rate resets. With the lower initial rate, you could also potentially pay off the mortgage faster by paying down the principle.

Starting year 11 the mortgage will reset once per year. The 10/1 is most similar to a fixed rate mortgage. You may notice that many of your friends and family haven't stayed in their home for 10 years. A 10/1 ARM might have been a wise decision for them.

Remember that when interest rates start to rise, the spread between the ARM and the conventional margin will widen.