ARMS – Great money saving mortgage product or buyer beware!

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Fixed rate loans versus ARMs is a hotly debated topic.  Proponents of each product have strong arguments why their particular favorite is better than the other.  I have seen numerous mathematical examples proving ARMs are better than fixed and vice versa.  So what is the truth?

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Which is better the ARM or the fixed rate loan?

The answer to this questions lies in the particular financial situation of the borrower and their tolerance for risk.   A properly selected mortgage is not a simple math exercise to determine which loan has the lowest interest rate.  While an ARM has a lower introductory rate than a fixed, if the borrower is risk averse the ARM, is not the right loan.   A mortgage is a personal product, it must fit the needs and risk tolerance of the borrower.

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ARMs – Some Basics

 Now, lets take a minute to explore ARMs.   An ARM is an Adjustable Rate Mortgage.  At specific periods of time the rate may go up or it may go down.  The most common ARMs in the mortgage world are  5/1 or  7/1.  The first number is the number of years before the first adjustment.  The second number is the number of years before each subsequent adjustment.  So a 7/1 ARM is an ARM that remains fixed for the first 7 years and then it may adjust depending on market conditions each 1 year thereafter.
Let’s go a bit further with our understanding of an ARM.  ARMS are tied to an index – such as LIBOR.  The interest rate of the ARM will adjust according to its index.  The margin is the interest percentage added to the index rate.  Hence a fully indexed rate is the index plus the margin.

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