An
adjustable-rate
mortgage (ARM)
has a variable
interest
rate:
The rate changes on a regular schedule — such
as once a year — to reflect fluctuations in market rates. When
overall interest rates decrease, the rate on your mortgage may drop
too. Then, the cost of your monthly mortgage payments may go down. But
if the rates overall increase, your payments may increase as well.
Many ARMs have low introductory rates, sometimes
called
teaser
rates,
for the first few months of the mortgage. For borrowers,
that means smaller monthly mortgage payments in the beginning
and reduced closing costs. So the teaser rate makes it easier
to qualify.
But, unlike fixed-rate mortgages, the total
cost of an ARM can’t be determined in advance. The changing
interest rate can make it harder for borrowers to budget their
housing costs.
Put a cap on it
ARM caps help ease this uncertainty somewhat.
All ARMs have
caps,
or limits, on the amount the interest rate can change. An annual cap limits the rate change each year
(usually to two percentage points), while a lifetime cap limits
the change over the life of the loan (typically to five or six
points).
Be careful though. Lifetime caps are often
based on the actual cost of borrowing at the time you took the
loan, and not on the introductory rate. For example, with a 6%
teaser rate and an 8.5% actual interest cost, your rate could
go as high as 14.5% with a 6-point lifetime cap.
