An adjustable rate mortgage (ARM) is a type of loan where the interest rate changes over time. The rate is usually tied to an index, such as the prime rate or LIBOR, and is adjusted at predetermined intervals, typically every 1-5 years. In contrast, a fixed rate mortgage (FRM) has a set interest rate for the entire loan term. While FRMs are popular because they offer stability and predictability, ARMs can also work in a borrower’s favor if certain conditions are met.

One reason someone might choose an ARM over an FRM is if they plan to sell or refinance the property before the rate adjusts. ARMs often have lower initial rates than FRMs, which can result in lower monthly payments and possibly even lower overall interest paid if the borrower does not keep the loan for the entire term. For example, a borrower with a $300,000 ARM loan at 3% for the first five years and 5% thereafter would have a monthly payment of $1,265.79, while a borrower with a 30-year FRM at 4% would have a monthly payment of $1,432.25. Over the first five years, the ARM borrower would save

$8,760. For someone who does not plan to stay in the home for longer than five years, the ARM could be a better option.

Additionally, an ARM can work in a borrower’s favor if interest rates decrease over time. While an FRM has a set interest rate for the entire term, an ARM can adjust to reflect changes in the market. If interest rates drop, the borrower’s monthly payment would also decrease, resulting in savings on their mortgage. However, it is important to keep in mind that interest rates can also increase, which could result in higher monthly payments and overall interest paid. Borrowers who choose an ARM should be prepared for this possibility and ensure they can afford the highest possible monthly payment before signing on to the loan.

It is also worth noting that not all ARMs are created equal. Borrowers should negotiate the terms of the loan and carefully review the interest rate cap and floor. The cap is the maximum amount the interest rate can increase at each adjustment interval as well as over the life of the loan, while the floor is the minimum interest rate. The borrower should ensure they can afford the highest possible monthly payment based on the cap and floor before signing on to the loan.

In conclusion, an adjustable-rate mortgage can work in a borrower’s favor if they plan to sell or refinance the property before the rate adjusts, interest rates decrease over time, and carefully negotiate the terms of the loan. However, an ARM also comes with risks, such as possible increases in interest rates, and borrowers should carefully consider their financial situation and consult with a financial advisor before choosing this type of loan.