What’s a 10/1 ARM?
An ARM is a mortgage with an interest rate that can adjust over time in response to changes in the market. The 10/1 ARM has a fixed interest rate for the first decade, followed by annual rate adjustments for the next 20 years. This makes it distinct from traditional fixed-rate mortgages which lock in one rate for the entirety of the loan term.
The beauty of the 10/1 ARM lies in the balance it offers: the certainty of a fixed rate for a substantial period and the potential savings from rate adjustments thereafter.
How the 10/1 ARM Rate Works:
Essentially, the interest rate on a 10/1 ARM is determined by a combination of a fixed margin rate and a variable index rate. The index rate reflects general market interest rates and can move up or down, while the margin remains constant.
Lenders often offer a cap on how much the interest rate can adjust. For instance, a 2/2/5 cap structure means:
A maximum of 2% increase at the first adjustment after 10 years.
A maximum of 2% increase for subsequent annual adjustments.
A total maximum of 5% increase over the life of the loan above the starting rate.
The Good and the Bad of 10/1 ARM:
Pros:
Initial Savings: With typically lower initial interest rates than fixed-rate mortgages, the 10/1 ARM offers initial cost savings.
Potential for More Home: The lower initial payment might enable you to afford a larger or better-situated house.
Further Savings: If market rates fall after the fixed period, your interest rate and payment can also decrease.
Cons:
Future Cost Risks: After the 10-year fixed period, you are exposed to potential rate hikes.
Complexity: With multiple variables at play – rate caps, index rate changes, and resets – ARMs can be complex to understand.
The Temptation of Interest-Only Payments: Some ARMs offer the option to pay only interest initially, but this can lead to much higher payments later and risk of negative equity if property values decline.
Comparing the 10/1 ARM with Other Mortgages:
10/1 ARM vs 5/1 ARM: The shorter five-year fixed period of the 5/1 ARM typically offers a lower initial rate but exposes the borrower to rate adjustments sooner.
10/1 ARM vs 7/1 ARM: With a 7/1 ARM, rate adjustments start after seven years, offering a middle ground between the 5/1 and 10/1 ARM.
10/1 ARM vs 30-year Fixed: While the 30-year fixed offers rate certainty, the 10/1 ARM can offer initial savings and the potential for more if rates decrease.
Is the 10/1 ARM for You?
The decision rests on your unique situation. Consider:
The initial rate being offered.
How long you intend to stay in the home.
Your risk tolerance regarding future rate adjustments.
If the initial rate is attractive and you don’t see yourself in the home for significantly more than a decade, the 10/1 ARM might offer significant benefits.
In conclusion, the 10/1 ARM presents an interesting option for homeowners who wish to capitalize on initial savings, while also taking a calculated risk on future interest rates. Schedule a consultation on our website and we can review if a 10/1 ARM is right for you.