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A Complete Guide to Adjustable Rate Mortgage (ARM) in Texas

May 15, 2023 | By Shoshana Simones

Table Of Contents

You want to buy a home in Texas - but which mortgage is right for you? It may be hard to make heads or tails - or ARMs - out of things!

Well, welcome to Texas United Mortgage's complete guide to Adjustable Rate Mortgages (ARM) in the great state of Texas! If you're a homebuyer in the Lone Star State, understanding the ins and outs of ARM can be a game-changer for your mortgage journey. As experts in the field who’ve helped thousands of customers with mortgages, we’re here to help. 

In this comprehensive guide, we'll dive deep into the world of ARMs, discussing how they work, their benefits and drawbacks, the different types available, qualifying factors, tips for managing them, and much more. So, let's embark on this exciting adventure and unlock the potential of Adjustable Rate Mortgages in Texas!

How Do Adjustable Rate Mortgages Work?

Unlike its fixed-rate counterpart, an ARM comes with an interest rate that adjusts periodically based on predetermined factors. 

“ARMs today are not the same as those that got a bad rap for contributing to the housing crisis in 2008,” shares Reef Mehri, Branch Manager at Texas United Mortgage. “Since then, regulations have been put in place to protect home buyers. So don’t let decades-old stories spook you now!” 

The adjustment frequency can vary, but common options include annually, every three years, or every five years. This means that your interest rate and monthly payment may fluctuate throughout the life of the loan.

Important Terms to Know About ARMs

Now that we’ve demystified the primary workings of an Adjustable Rate Mortgage, let’s dive into the more nuanced aspects. These important terms will help you understand the terms and conditions of these loans. 

  • Initial Period: ARMs typically start with an initial fixed-rate period, during which the interest rate remains unchanged. This period can range from a few months to several years, depending on the specific terms of the ARM.
  • Adjustment Period: After the initial period, the ARM transitions into the adjustment phase. During this phase, the interest rate can fluctuate periodically based on predetermined intervals, such as annually, every three years, or every five years.
  • Index and Margin: To determine the adjusted interest rate, ARMs use two primary components: an index and a margin. The index is a benchmark interest rate, such as the London Interbank Offered Rate (LIBOR) or the U.S. Treasury Securities index. The margin is a fixed percentage added to the index by the lender to establish the new interest rate.
  • Rate Adjustment: At the end of each adjustment period, the lender recalculates the interest rate based on the index's current value and the predetermined margin. The resulting interest rate becomes the new rate for the next adjustment period.
  • Rate Caps: Most ARMs have rate caps, which impose limits on how much the interest rate can increase or decrease during each adjustment period or over the life of the loan. Rate caps protect borrowers from excessive rate changes and provide stability.
  • Payment Adjustment: When the interest rate changes, it directly impacts the monthly mortgage payment. If the interest rate increases, the payment will likely rise as well, and vice versa. It's important for borrowers to anticipate potential payment adjustments and plan their budgets accordingly.
  • Lifetime Cap: In addition to periodic rate caps, ARMs often have a lifetime cap, which sets the maximum interest rate the loan can reach over its entire term. This cap offers protection against extreme rate increases and ensures that the loan remains within a manageable range.

What to Know About ARM Terms and Features

To make informed decisions about ARMs, you need to grasp the key terms and features. The initial fixed-rate period is the duration during which your interest rate remains unchanged. The adjustment period refers to the frequency at which rate adjustments occur. 

“The low rates are designed to draw you in,” shares Mehri. “We call them ‘teaser rates.’ Just like a low introductory rate on a credit card is intended to gain your business.” 

ARMs have interest rate cap structures, which limit how much your rate can increase or decrease during each adjustment period. Understanding the margin and index used for rate adjustments is also crucial, as they determine how your interest rate is calculated.

What are the Benefits and Drawbacks of ARMs?

ARMs offer distinct advantages that make them appealing to certain homebuyers. Firstly, they typically come with lower initial interest rates compared to fixed-rate mortgages, allowing you to save on monthly payments during the initial period. 

Secondly, if you anticipate rising interest rates, an ARM can be advantageous, as you may benefit from lower rates in the future. Lastly, ARMs offer flexibility for short-term homeownership, making them an excellent option for those planning to sell or refinance within a few years.

“If you only need it for a short period of time, it could be helpful,” says Mehri. “But keep in mind that when you buy down a rate, it’s for long-term gain. You won’t see a pay off until at least 3 or 4 years in, and the real benefit is in the 20 years after that.” 

The primary concern when taking out an ARM is the uncertainty of interest rate fluctuations. While rates can decrease, they can also rise, potentially leading to higher monthly payments in the future. Evaluating your financial stability and future plans is crucial to ensure you can manage potential rate adjustments effectively.

“Based on historic rate fluctuations, we can assume that rates will drop again eventually,” sys Mehri. “So if you can guarantee a lower rate for 3 to 5 years, or even 7, then plan on refinancing, that could work out. As long as you don’t spend too much to get that rate down now.” 

Types of Adjustable Rate Mortgages:

In Texas, several ARM types are commonly available, each with its unique characteristics. Let's explore some popular options:

3/1 ARM

With this type, the initial fixed-rate period lasts for three years, followed by rate adjustments annually.

5/1 ARM 

Here, you'll enjoy a fixed rate for the first five years, and thereafter, adjustments will occur annually.

7/1 ARM

This ARM provides a fixed rate for seven years before switching to annual adjustments.

10/1 ARM

With a 10/1 ARM, you'll experience a decade of fixed rates, after which adjustments will take place annually.

ARM vs. Fixed-Rate Mortgage: Which is Right for You?

Choosing between an ARM and a fixed-rate mortgage depends on various factors. Consider your long-term homeownership plans. If you plan to stay in the home for an extended period, a fixed-rate mortgage may provide stability and peace of mind. 

However, an ARM might be smart if you anticipate moving or refinancing within a few years. Assess current and projected interest rate trends and evaluate your personal financial situation and risk tolerance. By weighing these factors, you can make an informed decision that aligns with your goals.

Ultimately, the decision between an ARM and a Fixed-Rate Mortgage depends on your specific circumstances and preferences. It's essential to carefully assess your long-term homeownership plans, evaluate interest rate trends, and honestly evaluate your financial situation and risk tolerance.

You should always consult a mortgage professional who can provide personalized guidance based on your needs and goals. At Texas United Mortgage, we can help you navigate the pros and cons of each mortgage type, explain the potential financial implications, and assist in selecting the option that aligns with your unique situation.

Qualifying for an ARM in Texas

To qualify for an Adjustable Rate Mortgage in Texas, it's important to understand the lender's requirements and qualifications. While specific criteria may vary among lenders, certain factors commonly come into play.

One of the key factors lenders consider is your credit score. A higher credit score demonstrates your creditworthiness and increases your chances of qualifying for an ARM. Additionally, lenders evaluate your debt-to-income ratio (DTI), which compares your monthly debt obligations to your income. A lower DTI indicates better financial stability and improves your eligibility for an ARM.

When applying for an ARM, be prepared to provide essential financial documentation. This typically includes proof of income, such as recent pay stubs, W-2 forms, or tax returns. Lenders may also require bank statements to verify your assets and assess your ability to make mortgage payments.

3 Tips for Managing an ARM

Managing an Adjustable Rate Mortgage effectively is vital to ensure financial stability throughout the loan term. Here are some tips to help you navigate the world of ARMs:

  1. Budgeting and Planning: Understand that your monthly payments may change due to rate adjustments. It's important to budget accordingly and plan for potential increases. Set aside funds to cushion the impact of rate adjustments on your finances.
  2. Monitoring Interest Rate Trends: Keep an eye on interest rate trends to anticipate potential adjustments. Stay informed about market conditions and consult with your lender or financial advisor to make informed decisions regarding refinancing or adjusting your mortgage strategy.
  3. Exploring Refinance Options: If you anticipate a significant increase in interest rates, explore the possibility of refinancing your ARM into a fixed-rate mortgage. This can provide stability and lock in a predictable payment amount.

Get Started with the Right Mortgage

Congratulations! You've completed Texas United Mortgage's complete guide to Adjustable Rate Mortgages in Texas. Now armed with a comprehensive understanding of ARMs, their benefits, drawbacks, different types available, qualifying factors, and management tips, you're well-prepared to make informed decisions about your mortgage journey.

Remember, when considering an ARM, carefully evaluate your long-term homeownership plans, assess your financial situation and risk tolerance, and stay informed about market conditions. By doing so, you can harness the potential of an ARM and enjoy the flexibility and financial advantages it offers.

At Texas United Mortgage, we're here to assist you every step of the way. Our dedicated team of mortgage experts is ready to answer your questions, provide personalized guidance, and help you find the perfect mortgage solution tailored to your needs. So, whether you choose an ARM or a fixed-rate mortgage, we're committed to making your homeownership dreams a reality in the great state of Texas!

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