What is a 1-Year Adjustable Rate Mortgage?
Adjustable rate mortgages (ARMs) have grown in popularity since their inception. A lot of the renewed interest has come from the introduction of so-called “hybrid” ARMs, which are the result of combining a fixed rate mortgage with an adjustable rate mortgage. This is accomplished with an initial period of a fixed interest rate, that when expired, opens the rate up to being adjusted at set intervals. There are quite a few hybrid ARM products on the market, each one with its own level of value, depending on the borrower.
The most common hybrid adjustable rate mortgages are offered in basic forms such as the 3/1 ARM, the 5/1 ARM, and the 7/1 ARM. With these common arms, after the initial fixed period of 3, 5, or 7 years is up, the rate can then be adjusted annually, or every 1 year. While there is a 10/1 option available, and even options that raise the frequency of resets (i.e. every 6 months), one hybrid ARM product seems to be the black sheep of the lot.
The 1-Year ARM, though rare, is yet another hybrid ARM option available to borrowers. As the name suggests, a 1-Year ARM has an initial period of one year with a fixed interest rate. After the initial year, the fixed interest rate converts into an adjustable interest rate, that can be adjusted or “reset” on a yearly basis (annually).
1-Year Adjustable Rate Mortgage Basics
As with the other hybrid ARM products, a 1-Year ARM has two portions to contend with. This product has an introductory period of one year, in which the interest rate will remain fixed. Once the initial fixed rate period is over, the interest rate is open to being reset on a year to year basis.
Following the general trend for hybrid ARM products, the interest rate that is locked in during the initial fixed rate period is typically lower than what a borrower would get with a traditional fixed rate. Additionally, it is a typical practice that the shorter the introductory period on a hybrid ARM, the lower the interest rate for the fixed period. In that breath, it is safe to assume that the 1-year adjustable rate mortgage has a much lower interest rate than any of its siblings.
Of course, the benefits of having a lower interest rate with these types of loans only last as long as the introductory fixed rate period. In this particular case, borrowers will only benefit from lower monthly mortgage payments for one year. It is no secret that once the interest rate on a hybrid ARM becomes adjustable, there could be a significant increase in both the rate of interest and by extension, the monthly payment amount.
Interest Rate Caps
Because of the volatility of an adjustable interest rate, many hybrid adjustable rate mortgage packages come with interest rate caps. Interest rate caps, as the name suggests, are maximum amounts or “caps” that are applied to ensure that the interest rate doesn’t skyrocket to an unimaginable value in one adjustment.
Interest rate caps are typically implemented per adjustment, as well as for the overall value over the life of the loan. This is so that each adjustment can only raise the interest rate on the home loan in predetermined incremental amounts, and over the life of the loan, keep the interest rate from rising well over the index value from the date the loan was originated.
Interest rate caps have been an incredibly welcomed update to adjustable rate mortgage loans. Still, they can only accomplish so much. The most important thing to remember is that regardless of the caps in place, your interest rate and monthly mortgage payment is almost sure to increase during the adjustable phase.
That’s not to say that decreases don’t also happen, it is just that increases account for the majority of cases, since the initial fixed rate period of a hybrid adjustable rate mortgage already boasts a lowered interest rate than the market standard.
When to get a 1-Year ARM
Adjustable rate mortgages, more specifically, hybrid ARMs thrive in the mortgage industry for what they can do for the right borrower. Getting into any adjustable rate loan can be risky, but at least hybrid ARMs offer an initial period when borrowers can rely on a set interest rate. The 1-Year adjustable rate mortgage provides one year of this initial fixed period, with an interest rate lower than even a 3/1 ARM could offer.
Nonetheless, the 1-year ARM is not exactly the most popular of the hybrid ARMs. Easily having the shortest initial rate period of only one year, makes it hard to deny that this is the riskiest hybrid ARM option. After all, if a borrower wanted to cash in on those early savings and then switch to a fixed rate, they would have to refinance after only 1 year into the loan term.
Needless to say, this option isn’t the best for borrowers who plan to settle into a place permanently or for a long period of time. If refinancing becomes a no-go, you could be stuck with troublingly high monthly mortgage payments and an interest rate that won’t stay put. While you can never truly foresee where the interest rate will be in say, 3 years, using the interest rate caps to help determine some of the higher end payments you may be responsible for in the long run is a great way to help decide whether the 1-year ARM is an affordable option.
Borrowers looking to make some huge savings in their first year of a mortgage loan agreement might not be able to find a more appealing option on the market. The risk may be high, but so is the reward. Besides, in some cases, the interest rate may actually decrease, then you’re looking at even more savings.
Still, this loan is at its best when a borrower can bale out with a refinance and switch to a more stable or affordable loan option soon after that first year of awesome savings is over.