Adjustable-Rate Mortgages (ARMs)
An adjustable-rate mortgage (ARM) is a home loan that starts with a low fixed interest rate for an introductory period and is followed by periodic rate adjustments once the initial fixed-rate period ends.
What are the possible benefits of an Adjustable-Rate Mortgage (ARM)?
An ARM can be a great choice for the right homebuyer and homeowner.
- Low, fixed rates for the initial introductory period
- Ideal for homeowners planning to relocate or pay off mortgage in 10 years or less
- Take cash out of your equity while maintaining a low monthly payment
- Wide range of down payment options
What Is an Adjustable-Rate Mortgage (ARM)?
An adjustable-rate mortgage, or ARM, is a home loan with two different phases: The first phase offers low payments at a fixed interest rate. This rate is usually very competitive — less than what fixed-rate mortgages can offer. After the first phase ends, you continue paying off your loan at a rate that will adjust periodically.
These mortgages are more straightforward than they may initially seem, and can offer significant savings and flexibility for homebuyers who are prepared to take advantage of their unique features.
How Adjustable-Rate Mortgages Work
If you are considering an adjustable-rate mortgage for your home buying needs, it’s important to be sure that you know exactly how these loans work. ARMs are mortgages with two phases: an initial fixed-rate period, followed by a period in which the interest rate on your loan will adjust according to market fluctuations.
- 10/6 Adjustable-Rate Mortgage (ARM): This loan offers 10 years of low payments at a fixed interest rate. After 10 years, the interest rate on this loan will adjust bi-annually (every six months).
- 7/6 Adjustable-Rate Mortgage (ARM): This loan, which is the most popular adjustable-rate mortgage choice, offers seven years of low payments at a fixed interest rate. After seven years, the interest rate on this loan will adjust bi-annually (every six months).
- 5/6 Adjustable-Rate Mortgage (ARM): This loan type offers five years of low payments at a fixed interest rate. After five years, the interest rate on this loan will adjust bi-annually (every six months).
ARM Rate Indexes and Margins
The aspect of ARMs that typically confuses homebuyers is the adjustable-rate period. They often have questions regarding how much their interest rate could change, and why it might change. Your rate won’t change randomly — It will be based on two things: The index and your loan’s margin.
The index is a gauge that is based on external market conditions, and it will change based on those market conditions. A common index used in ARMs is the SOFR Index Averages (New York Fed), which is largely determined by the U.S. Federal Reserve’s target range for the federal funds rate.
Your loan’s margin is a percentage point added to the index by your lender. The index plus your margin are combined to create the adjustable interest rate you will pay. This is why adjustable ARM rates are often defined in terms like “Prime + 1.” What all of this means is that any adjustable rate changes will be easy to understand, and driven by market movements that will impact nearly all other financial products as well.
In addition to being tied to larger financial market changes, ARM rates are also typically capped in several different ways.
- Initial adjustment cap:This limits how much the interest rate can increase the first time it adjusts after the fixed-rate phase of your loan ends.
- Subsequent adjustment cap:This limits how much the interest rate can increase during the subsequent adjustment periods that follow your first adjustment. This cap is usually around 2%: This means that your new rate can’t go up more than two percentage points more than your previous rate.
- Lifetime adjustment cap:This limits the total interest rate increases possible, over the duration of your entire loan. This cap is usually around 5%, so your interest rate will never be more than five percentage points higher than your initial rate.
- Payment cap:This limits the amount that your monthly payment on an adjustable-rate mortgage loan can change.
Types of Adjustable-Rate Mortgages
There are several kinds of adjustable-rate mortgages you can choose from, depending on whether you want to buy a new home or are thinking of refinancing to either potentially lower your payment or take cash out of your home’s available equity. Below is a breakdown of the various Conventional ARM options (Fixed Period ARMs) available with Pennymac.
Pennymac offers several conventional ARM options to help borrowers purchase the home that best suits their life plans. Choose from a low fixed-rate introductory period of either 5, 7 or 10 years. Down payments can be as low as 5%, while a 20% down payment allows borrowers to skip mortgage insurance requirements. (Once an 80% Loan-to-Value is reached an appraisal will enable the removal of mortgage insurance.) This type of home loan can be a great option for homebuyers planning on relocating or paying off their mortgage in 10 years or less. Multiple property types can be financed, including second homes and investment properties.Rates & More Info
- Down payments as low as 5%
- Fixed Period ARMs with a 5, 7 or 10-year fixed-rate introductory period offered
- Can be used for several property types, from single-family homes to condominiums
Homeowners can take advantage of the low introductory rates offered through Fixed Period ARMs to reduce their current mortgage payment. And with no prepayment penalties, borrowers can make extra payments to increase the equity they own at an introductory rate lower than standard fixed-rate mortgages.Rates & More Info
- Choose an introductory fixed-rate period of 5, 7 or 10 years
- Avoid mortgage insurance with an 80% LTV or lower
- Refinance whenever you want; no prepayment penalties
A Conventional ARM Cash-Out Refinance can allow you to turn the equity in your home into cash while maintaining a similar low introductory payment that you may have had with a previous fixed-rate mortgage. Typical uses for the cash received from this type of refinance are for home improvements, paying off high-interest debt, funding an education or any other expense that you may want to eliminate.Rates & More Info
- Increase the value of your home using your home equity for improvements
- Save on interest when you consolidate all of your high-interest debt with the low introductory rates offered
- Eliminate auto loans and credit card bills
ARM Loan Benefits
Adjustable-rate mortgages come with several advantages, and one of the most popular is very low interest rates during the initial fixed-rate period. This can provide significant interest savings (and potentially more equity) for those who plan to pay off their home rapidly, relocate frequently, or anticipate other changes in their financial or personal life.
In addition, if rates go down, you can take advantage of a lower interest rate on your mortgage without having to refinance.
Get an Adjustable-Rate Mortgage Today
Adjustable-rate mortgages are a valuable investment strategy for numerous home buyers. Ready to discuss your ARM options? Contact a PennyMac Loan Officer today to learn more.
Refinancing your existing loan may result in your total finance charges being higher over the life of your loan.
Resources & Tools
Mortgage rates have been at record lows for nearly two years. Learn what the Fed’s tapering is and what it can mean for rates in the foreseeable future.
Unsure if an adjustable rate mortgage is right for you? Get the inside scoop on the ARM and learn whether the risks of this loan type are worth the reward.