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The Consumer Handbook developed by the Federal Reserve Board defines Adjustable-rate mortgages (ARMs) as loans with interest rates that change. According to the Board, an ARM differs from a fixed-rate mortgage in many ways. It points out that with a fixed-rate mortgage, the interest rate stays the same during the life of the loan while with an ARM, the interest rate changes periodically, usually in relation to an index, and payments may go up or down accordingly.
The Handbook reminds us: "Shopping for a mortgage is not as simple as it used to be. To compare two ARMs with each other or to compare an ARM with a fixed-rate mortgage, you need to know about indexes, margins, discounts, caps on rates and payments, negative amortization, payment options, and recasting (recalculating) your loans. You need to consider the maximum amount your monthly payment could increase. Most important, you need to know what might happen to your monthly mortgage payment in relation to your future ability to afford higher payments.

"Lenders generally charge lower initial interest rates for ARMS than for fixed-rate mortgages. At first, this makes the ARM easier on your pocket than a fixed-rate mortgage for the same loan amount. Moreover, your ARM could be less expensive over the a long period of time than a fixed-rate mortgage---for example, if interest rates remain steady or move lower.

"Against these advantages, you have to weigh the risk that an increase in interest rates would lead to higher monthly payments. in the future. It's a trade-off---you get a lower rate with an ARM in exchange for assuming more risk over the long run." 
HANDY TIP from the Board to anyone looking for the right loan or considering to refinance is to ask this question:

Is my income enough--or likely to rise enough--to cover higher mortgage payments if interest rates go up? 
Article by Connie I. Ko
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  • Last edited September 24 2012
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