A 10/1 ARM (adjustable-rate mortgage) is often one of the best alternatives to choosing a 30-year fixed-rate mortgage. Here are the basics of the 10/1 ARM and what it can provide to you as a consumer.
What Does 10/1 Mean?
The 10 means that you will have 10 years of a fixed interest rate. During that period, you will have the same monthly mortgage payment as well. The 1 means that after the 10 years is up, your interest rate is going to be changed on an annual basis. At that point, your mortgage payment is going to fluctuate from one year to the next.
The interest rate does not move based upon the whims of someone that works for your lender. In fact, the interest rate is tied to a particular financial index in the market. As the index moves up and down, your interest rate is going to move up and down as well. When you sign the loan documents, your lender's representative will explain to you that there is a particular margin that will be added onto or subtracted from the financial index.
For example, many adjustable-rate mortgages track the movements of the one-year constant maturity Treasury. If this index moves up, your interest rate will move up as well.
It is important that you understand what financial index your 10/1 ARM is tied to so that you will know what to expect at the end of the year.
Benefits of a 10/1 ARM
Perhaps the biggest benefit is that you can have 10 years of a lower interest rate than what you can get from a 30-year fixed mortgage. Most people do not live in their houses for more than 10 years in today's society. Therefore, if you plan on selling your house within 10 years, there is no point in locking in an interest rate for 30 years. You can take advantage of the lower payments for the first 10 years of the mortgage and then sell your home or refinance.
Interest Rate Maximum Increases
With a traditional 10/1 ARM, the loan will have a maximum on the amount the interest rate can increase from one year to the next. For example, the rules of the mortgage might state that the interest rate cannot increase by more than 1 percent per year regardless of what the financial index does. In addition to this, many 10/1 ARMs will also have a maximum that the interest rate can get to over the entire life of the loan. This provides you with some protection as a borrower and prevents your payment from getting too high.