A: Because adjustable rate mortgages, or ARMs, fluctuate with the market, they offer less stability than fixed-rate loans. If an ARM is adjusted upward, monthly payments will increase, and for a lot of people that can be too big a risk to take. On the other hand, should rates drop dramatically, homeowners can reap the benefits of lower rates without refinancing, thereby saving thousands of dollars.
Lenders first introduced ARMs in the 1980s when interest rates soared into the double digits, forcing many people out of the home buying market. They tied the rate to a variable national index, such as U.S. Treasury bills.
Today, many first-time buyers who have difficulty qualifying for a home loan, still settle for adjustable rate loans because the initial, “teaser” interest rate of the mortgage is normally two or three points lower than a fixed rate loan. ARMs are particularly attractive if you plan to be in your home a short time. They tend to adjust yearly or every three years, usually within certain limits, or caps, that prohibit the interest rate from shooting up too high. Make sure terms such as these are spelled out in any ARM agreement you choose.
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