Adjustable Rate Mortgage
Also referred to as a ARM, the interest rate is not fixed but varies at specific times throughout the loan. Another characteristic of this loan is that it has a balloon payment due at a preset point. At that point the remaining principle is due and payable, you are free to pay off, refinance with another lender, or renegotiate a continuance of the arrangement with possibly a different interest rate.
– 5 year arm with a 30 year amortization at 5 percent interest.
In this example you are paying 5 percent interest for the first 5 years and the amounts of your payments are figured out on a 30 year amortized basis. After 5 years either you or the lender can decide to come to a conclusion of the loan which entails you paying them the remaining balance. This is considered a balloon payment and obviously can be a very substantial amount.
Dont freak out, at this point the bank will most likely either continue on the same terms or will propose to you to raise or lower the interest rate. Your payment amount will change, in this case, but the other terms will remain the same. This is assuming you have paid as agreed, if not they may not want to continue the loan.
ARM’s are usually used for comercial/investor loans. My owner occupied home loan has always been fixed and most rental properties have been 3 year or 5 year arms. In my case the amort. has usually been 25 years.
Why accept the uncertainty of the ARM? For one, in most situations a conventional loan isn’t offered for investment properties. Additionally, if you plan to sell soon than take the ARM since the interest is gonna be lower in the beginning. If you believe interest rates will decline than you may want the arm to take advantage of that trend.
ARM’s can be used for a primary residence but with interest rates being historically low for the last decade or more theres not much incentive to choose this route.
There you have it- a general definitions of an adjustable rate mortgage or ARM for short.