Adjustable Rate Mortgages are loans with a 25-30 year term, but have a lower initial interest rate for a fixed period of time. This interest rate can increase or decrease according to the market.

The interest rate variation in the market then applies to your mortgage so that if interest rates go up, this will apply to your mortgage also and the same applies if they drop. The rates you pay is fixed for a short-term in the beginning and after that it varies on a daily basis if necessary. This type of loan is a lot riskier than a fixed loan, so if the term of loan is to be kept short it's good to go with ARM. This risk led to refinancing Adjustable Rate Mortgages. The idea behind such kind of loan is that you should be able to pay off the loan within a fixed amount of time as the interest rates on such a loan are higher and can climb without any prior information on the market.

ARM rates are tied to a major index such as prime rate or one year US Treasury bill. If the index goes up so will your interest rate and your payment, a drop in index rate will reduce your payment. ARM rates change once or twice a year and the amount of change is limited by a periodic rate cap- usually 2% up or down. The rate can never go above the ARM lifetime cap, which is typically 6% above the initial rate. This variation or a fear of rise in interest rates is what directs people into refinancing.

A three-year or five-year ARM has interest rates fixed for three or five years and after this period interest rates vary. These rates are much lower than comparable fixed rate mortgages. They form a very attractive plan if you refinance before the rate adjusts or you plan to shift your home. Studies reveal that first time homebuyers are good candidates for ARM, as they move to larger homes or refinance after 5 years.

Another benefit of Adjustable Rate Mortgage (ARM) is that it allows a homeowner to build equity faster than a fixes rate loan. So refinancing and taking home equity loan is easier here. If you come across unforeseen interest hike, or you want to extend your stay in your home, refinancing to a low fixed rate comes to your rescue.

If you live in a housing market that is appreciating time and again, you can expect to refinance in order to get the most out of equity.
Last few year's figures show
YEAR 30-year Fixed Mortgage 1-Year Adjustable mortgage:-

2002 5.97 4.12
2003 5.82 3.87
2004 6.12 5.11
2005 6.89 5.09

The above figures always direct you to go for ARM if the term is small and refinance to fixed rate if you plan a longer mortgage.

ARM of smaller fixed years hand in hand with refinancing has good benefits and cover a lot of homeowners requirements.


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