10/1 ARM: 10/1 Adjustable Rate Mortgage in Home Loans

10/1 ARM Basics 

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A 10/1 ARM is one type of hybrid adjustable-rate mortgage. Much like other hybrid loans, a 10/1 ARM has a fixed period (in this case, 10 years) during which your interest rate won’t change. That makes it one of the safest types of hybrid mortgages, as it gives you a lot of time to figure out your financial situation and determine whether you want to continue owning your home after the adjustable-rate period begins.

What Is a 10/1 ARM? How Are ARMs and Fixed-Rate Mortgages Different?

So what is a 10/1 ARM, anyways?

It’s important to start with defining a fixed-rate mortgage. A fixed-rate mortgage will have the same interest rate throughout the life of the loan. With a fixed-rate mortgage, you’ll always know the amount of your monthly mortgage payment. But with a hybrid ARM, the interest rate can change after a specific time period. This usually means an interest rate increase.

You see two numbers for an adjustable rate mortgage, or ARM. The first number specifies the number of years the interest rate will be fixed. The second number indicates the number of years the ARM rate will change over the remainder of the loan term.

For example, a 10/1 ARM has a fixed rate for ten years. After those ten years are up, the interest rate adjusts annually. The interest rate is based on a benchmark interest rate chosen by the financial institution. If the benchmark interest rate goes up, your payments go up. Likewise, if interest rates go down, your monthly payment may be reduced as well. Some ARMs set caps that limit how high or low your interest rate can go.

What happens after the first 10 years of a 10/1 ARM mortgage?

After the first 10 years of a 10/1 ARM, the adjustable-rate period kicks in, which means you might have to start paying a lot more each month on your mortgage. After the 10-year period, the rate you’ll pay is adjusted every year, hence the “1” part of the 10/1 ARM.

Can you get a 10/1 ARM on a jumbo or non-conforming mortgage?

If you’re planning to get a non-conforming or jumbo mortgage, you can still get a hybrid loan like a 10/1 ARM. Whether it’s because your credit isn’t stellar, or because you want to purchase a home that costs more than the conforming loan limit for your state, a 10/1 jumbo ARM can still be an option.

When is an 10/1 ARM a good home loan option?

It depends entirely on your unique financial situation. With any adjustable-rate loan, the borrower should be willing to take on a little more risk. It also helps to have a great credit score along with a decent amount of cash reserves. Since a 10/1 ARM gives you a lot more wiggle room, it can be appropriate for people with a medium level of risk tolerance who just want to lock in a good rate. In some cases, that might even include first-time home buyers who were initially considering a 30 year fixed-rate mortgage.

Either way, if you’re getting a hybrid loan, you should be prepared to sell or refinance the home after the fixed-rate period ends, unless you’re prepared to pay the highest possible interest rates when the fixed term is over.

Those who are unafraid of risk might prefer a different home loan option, like a 5/1 ARM or a 7/1 ARM, which have 5- and 7-year fixed-rate periods, respectively. These loans often have the lowest possible interest rates.

What is a lifetime cap on a 10/1 ARM?

You already know that interest rates can climb steadily after the fixed-rate period on your 10/1 ARM ends. But just how high can they go? That depends on what’s called a lifetime cap. The lifetime cap is the maximum interest rate allowed to be charged during the life of the mortgage. Most of the time, this is expressed as a percentage increase from the initial (fixed) rate. So, if you’re getting a 10/1 ARM with a fixed rate of 4%, and the lifetime cap is 4%, the maximum interest you’ll pay is 8%.

Fortunately, however, your interest rate is unlikely to jump from 4% to 8% in just one year, since ARMs also usually have periodic caps. A periodic cap is a limit on the percentage that a mortgage can increase during an adjustment interval.

For a 10/1 ARM (or any ARM with a “1” at the end), that’s one year. So, if your periodic cap is set at 1%, in the example above, your rate could only go as high as 5% in one year. And, it would take an entire 4 years for your rate to go up to 8%.

Can a 10/1 ARM mortgage help you build equity?

The ARM’s first advantage is the lower interest rates during the fixed period of the loan. This can help you build equity in the home faster, if you plan carefully. One strategy is to take out a 5/1 ARM but make monthly payments as if it were a 30-year fixed mortgage. By the end of the 5-year fixed period, the borrower will have made a much larger dent in their balance than the borrower who uses a 30-year fixed mortgage.

After five years of equally sized payments, the buyer who used the 5/1 ARM instead of a 30-year mortgage would be more than $7,200 closer to paying off the home in full.

Having more home equity is a powerful buffer should interest rates rise. If, at the end of five years, your rate rises by more than 1 percentage point (from 3.2% to 4.25%), your monthly payment will simply match that of the 30-year fixed-rate mortgage. Of course, the $7,200 in additional home equity you built up is yours to keep.

How risky is a 10/1 ARM?

Before choosing a mortgage product, it’s critical to consider how long you might remain in your house. For instance, buyers aged younger than their mid 30’s usually expect to stay in a house for about 10 years. On the other hand, buyers 52 to 61 years old typically plan to live in a house for at least 20 years, according to the National Association of Realtors.

If you anticipate moving before the initial 10-year interest rate expires, you will reap savings at no added risk by taking out a 10/1 ARM. But if there’s a chance you might stay in your house for more than 10 years, you run the risk that interest rates could adjust higher in the future, which will make an ARM more expensive in the long run.

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