How Does an Interest Only ARM Work?

An interest only ARM (adjustable-rate mortgage) combines fluctuating interest rates with an interest only repayment period. Interest only ARMs stretch the same lengths as other types of mortgages; 15-year, 30-year and 40-year interest only ARMs are most common.

Interest rates remain level for a certain period ("introductory rate") before resetting. The introductory rate may last for 1, 3, 5, 7 or 10 years and can reset every month, 3 months, 6 months or year. 

The borrower is allowed to pay only the interest on the loan during the mortgage's early years, usually 3 to 5 years. 

The interest only period and the introductory rate may end at the same time or different times. For instance, the rate might reset after 3 years, while the interest only period ends after 5 years.

During the interest only period, any payment made towards principal will lower the minimum interest payment due the following month. Continuously repaying principal during the interest only period prevents an unmanageable jump in the minimum payments later in the loan.

Interest only ARMs are best suited to borrowers who can pay chunks of principal during the interest only period. Borrowers seeking lower monthly payments should not consider an interest only ARM unless they know they can manage the higher mortgage payments after the interest only period ends.

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