The Pros and Cons of Adjustable Rate Mortgages

An adjustable rate mortgage (or ARM) is a mortgage where the interest rate changes periodically, usually according to some sort of index, and the payments will go up or down accordingly. Don't be fooled by the 'down' part of that statement. I have never known anyone to have an adjustable rate mortgage and see their payment actually go down.

To many borrowers, the adjustable rate mortgage seems like a good idea. The initial interest rate (and there for the payment) is usually lower than with a fixed rate mortgage. The borrower might also qualify for a higher loan if the lender is only considering the ability to repay the loan based on the initial monthly payment. There is also the teasing possibility that the rate will go down, lowering the payment even further.

The problem with an adjustable rate mortgage is the very real possibility that the interest rate will go up - and the borrower's income will not. Some adjustable rate mortgages also have a prepayment penalty for if you pay the loan off early. Allowing a prepayment penalty in your mortgage contract is never a good idea.

An adjustable rate mortgage is not always a bad idea. If the borrower is only planning to remain in the house for a couple of years - three to five - then taking advantage of the lower initial interest rate is not a bad idea.