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An Adjustable Rate Mortgage (ARM) is a loan which interest rates and payments fluctuate depending on market interest rates. A typical ARM interest rate is adjusted annually after an initial period, which ranges from1 to 5 years depending on the terms of the ARM. ARM is described with figures such as 1-1, 3-1, and 5-1. The first figure in each set refers to the initial period of the loan, during which your interest rate will fixed, the second figure refers to the period between rate adjustments, in unit years. This rate is linked to an economic index. Increases are usually capped for any given year and for the life of the loan.
When should you consider an ARM? The biggest attraction of an ARM is that its initial interest rate is significantly lower than a fixed rate mortgage. As such, the payments are more affordable, and hence you can qualify for a larger loan based on your income level. So, if you expect your income to rise in the next few years, an ARM allows you to borrow a larger amount, while being able to afford smaller payments now, and increasing the payments as your income grow. In short, you can future proof your purchase by buying a bigger house that you can still afford now.
In addition, statistics show that the average American moves every 7 years. As such, the premium you pay to obtain a fixed rate mortgage may not be fully realized. By taking an ARM, you benefit from the lower initial interest rates, and at the end of the initial period, you may be already moving into a new home and a new loan.