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What Is Adjustable Rate Mortgage (ARM)

Aug 19, 2008
An Adjustable Rate Mortgage (ARM) is one of the most popular options available for both home mortgages and re-financing. Many homeowners do not fully understand the concept of an ARM and as a result may be somewhat hesitant to pursue this type of a mortgage.

This is a shame because there are some situations in which an ARM or a hybrid mortgage can be the best mortgage solution for a homeowner who is in the process of re-financing.

This article will focus on explaining the concept of an ARM, explaining situations where it is the best solution, debunking the most popular misconception regarding ARMs and explaining how those with bad credit can benefit from an ARM. At the conclusion of this article the reader should have a better understanding of ARMs and should be inspired to investigate this re-financing option further.

What is an ARM?
An ARM is an acronym for an adjustable rate mortgage. This means the interest rate associated with the mortgage is not fixed. Instead it is tied to an index such as the prime index and may rise and drop as the associated index rises and drops.

The fact that interest rate is variable scares away many homeowners from considering this option further. However, there are certain safety measures in place which protect the homeowner from rapid increases.

This safety measure will be discussed in greater detail later in the article on the section on the biggest myth regarding an ARM. However, for now homeowners should simply be aware that they would not be subjected to incredibly high interest jumps during a short period of time.

The Biggest ARM Myth
The variability of the interest rate in an ARM makes many homeowners feel very apprehensive. These homeowners envision interest rates going through the room during their loan term and resulting in their monthly payments skyrocketing. However, fortunately for these homeowners, rapidly increasing interest rates may not have a significant effect on ARMs.

This is because most ARMs have a built in clause which prevents the interest rate from rising more than a certain amount during a specific time period. During this time the national interest rate may rise significantly more but there is a cap on the amount the homeowner's interest rate will be raised.

When is an ARM Desirable?
One of the most desirable situations for an ARM is as a part of a hybrid mortgage. Hybrid mortgages typically have one component which is fixed and one component which is adjustable.

These types of mortgages may have a fixed rate for a set number of years begin to vary after this initial period. Alternately a hybrid loan may be variable for a number of years and then become fixed after this initial period.

The loan which begins with a fixed rate is usually desirable because the introductory rate is typically lower than the rate offered on traditional fixed loans for homeowners with comparable credit ratings. Homeowners may particularly like this option if they are repaying a smaller second mortgage and may be able to repay the loan in full before the introductory period ends.

ARMs for Those with Bad Credit
ARMs can also be very helpful for assisting those with bad credit in purchasing a home for the first time. There are a variety of loan options available today which makes it possible for even homeowners with poor credit to obtain a home loan.

However, those with bad credit are usually offered these loans with unfavorable terms such as higher interest rates. Additionally, lenders may only be able to offer those with poor credit an ARM.

Lenders take a significantly greater risk when they lend money to a homeowner with bad credit. As a result the lenders usually compensate for this increased risk by shackling the homeowner with less favorable such as a mortgage with an adjustable rate as opposed to a fixed rate.
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