With an adjustable rate mortgage (ARM), the interest rate may go up or down. Many ARM's will start at a lower interest rate than fixed rate mortgages. This initial rate may stay the same for months or years. When this introductory period is over, your interest rate will change and the amount of your payment will likely go up.
Part of the interest rate you pay will be tied to a broader measure of interest rates, called an index. Your payment goes up when this index of interest rates moves higher. When interest rates decline, sometimes your payment may go down, but that is not true for all ARM's. Many ARM's will limit the amount of each adjustment, and set a maximum or “cap” on how high your interest rate can go over the life of the loan. Some ARM's also limit how low your interest rate can go.
Tip: Know how your ARM addjusts
Before taking out an adjustable rate mortgage, find out:
How high your interest rate and monthly payments can go with each adjustment
How frequently your interest rate will adjust
How soon your payment could go up
If there is a cap on how high you interest rate could go
If there is a limit on how low your interest rate could go
If you will still bee able to afford the loan if the rate and payment go up to the maximum allowed under the loan contract
Tip: Don't assume you'll be able to sell your home or refinance your loan before the rate changes.
The value of your property could decline or your financial condition could change. If you can't afford the higher payments on today's income, you may want to consider another loan.