With interest rates on home loans climbing, homebuyers — or homeowners looking to refinance — might be tempted by the lower initial cost of an adjustable-rate mortgage.
Yet before you sign on the dotted line for a so-called ARM, it's important to understand what you're getting into.
"You need to know the exact terms of the ARM, not just the interest rate at the beginning of the loan," said Stephen Rinaldi, manager at Pando Mortgage in Media, Pennsylvania. "Don't buy into an ARM thinking the rate will stay low forever."
With an ARM, the initial interest rate — which generally is lower than that on a traditional 30-year fixed mortgage — is only fixed for a set amount of time.
After that, the rate could go up or down, or remain unchanged. That uncertainty makes an ARM a riskier proposition than a fixed-rate mortgage. This holds true whether you use an ARM to purchase a home or to refinance a loan on a home you already own.
The ARM adjustment is based on a widely used interest rate index, along with the specific terms of your loan (more about that further below). Commonly used benchmarks include the one-year Libor, which stands for the London Interbank Offered Rate, and the weekly yield on the one-year Treasury bill.