How Do ARMS Work?

Calgary-Mortgage-BrokerWith a fixed-rate mortgage, the interest rate and your payments stay the same throughout the life of the loan. However, with an adjustable rate mortgage, the interest rate changes periodically – typically once a year. This interval between potential rate changes is called the adjustment period. The rate is usually set in relation to an index; your payments go up or down according to changes in the index rate. For example, suppose you are going to take out a $100,000 mortgage. Your lender offers you a 30-year fixed rate mortgage at 6 percent, or a one-year ARM at 4.25 percent. After that first year, however, the rate on the conventional 30-year mortgage remains 6 percent, while the rate on the ARM is adjusted to match the current index rate. If that rate has gone up one percent, you’d now be paying 5.25 percent. If it’s fallen one percent, you’d be paying 3.25 percent. So, in exchange for a lower initial rate, you give up the security of knowing what interest rate you’ll pay from year to year, and what your monthly payment will be. You get the potential for lower payments if interest rates fall while you hold the mortgage. But you also face the possibility of paying more if interest rates rise.

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