Once the introductory period is up, the interest rate moves up and down with another interest rate, called the index.
ARMs have caps that limit the amount rates and payments can change.
For example, if you don’t plan to stay in the house long enough for the introductory rate to expire, an ARM might make sense because you’ll likely get a lower interest rate than you would with a fixed-rate mortgage.
Another group of borrowers who could benefit from an ARM are those who have a significant income and can afford to pay off the mortgage within the fixed period, thereby taking advantage of the low introductory rate.
“Instead of going out and taking a 15-year fixed, these borrowers want the lower monthly payment on a five-year ARM so that they can maximize how much goes to pay off principal during that period,” Jones says.
For example, let’s say you have a $300,000 5/1 ARM for 30 years, and the introductory rate is 4 percent.
For the first five years, your fixed monthly payments would be $1,432.
If your rate increases 0.25 percent every year after the introductory period, you’ll end up paying $1,799 each month by year 15.
By year 30, your monthly payments will be $2,020, and your interest rate will be 10.25 percent.
If you currently have an adjustable-rate mortgage and are facing interest rate adjustments, consider refinancing into a 15-year mortgage or 30-year mortgage.