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Understanding Adjustable-Rate Mortgages (ARMs)

Adjustable-rate mortgages, or ARMs, have seen a resurgence after a decade of low interest. These mortgages often offer lower introductory rates compared to conventional fixed-rate mortgages, making them an attractive option in today’s market with rising home prices and interest rates.

What Is an Adjustable-Rate Mortgage (ARM)?

An adjustable-rate mortgage (ARM) is a type of mortgage where the interest rate is fixed for an initial period and then adjusts periodically. The most common type is the 5/1 ARM, which has a fixed rate for the first five years and then adjusts annually. Other variations include 2/1, 7/1, and 10/1 ARMs.

How Does an Adjustable-Rate Mortgage Work?

During the fixed-rate period of a 5/1 ARM, the interest rate is typically lower than that of a comparable fixed-rate mortgage. After this period, the rate adjusts based on a market index plus a margin. For example, in May 2023, many 5/1 ARMs had a variable rate of 4.75% plus a 2.75% margin, resulting in a 7.50% APR.

ARMs Get More Popular When Rates Are Higher

ARMs become more attractive when fixed mortgage rates are high. For new homebuyers, the lower initial payments of an ARM can make homeownership more accessible. In 2022, the share of ARM originations increased significantly as interest rates rose.

Are ARMs a Good Decision?

Whether an ARM is a good choice depends on your situation. If you plan to move before the fixed-rate period ends or expect your income to increase, an ARM could be beneficial. However, you still need to qualify for the mortgage, just like with a fixed-rate loan.

ARMs Are Changing, but Payments Will Remain Nearly the Same

In 2023, the variable-rate portions of ARMs are transitioning to the Secured Overnight Financing Rate (SOFR). This change is expected to keep payments nearly the same as before, as SOFR closely tracks the federal funds target rate.

For any mortgage-related needs, feel free to call O1ne Mortgage at 213-732-3074. Our team is ready to assist you with confidence and expertise.

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