Question:

How does an adjustable rate mortgage work?

Answer:

An adjustable rate mortgage works in the following way - it starts with a rate lower than the rate of a fixed rate mortgage for the same term. In the case of a 3/1 ARM the introductory rate remains stable for three years, after the expiration of which the rate adjusts yearly according the ARM index it is tied to. Thus your payments may be going up or down, but never above a preset cap.

The way an adjustable rate mortgage works for a homebuyer depends on how long the borrower is willing to keep that home. For example, a borrower wants to stay in the house for several years, and then refinance. It is cheaper to get an adjustable rate mortgage work for you providing you with low monthly payments.

Since many ARMs come with an interest-only option, it is great to have a low monthly payment, lower than what normally rent would be, and then at the end of the fixed period you could sell the house or refinance, or even choose to keep the house.

An adjustable rate mortgage will work great for people who either do not know whether they want to keep this home, or expect to be able to afford the increase in payment in a few years.

Recommended helpful present and future homeowners links:
Why: Refinance to a fixed rate loan while mortgage rates are still low.
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Common misspellings: mortage and morgage