How to avoid the worst in terms of ARM and fixed rates. It depends on your mortgage needs. When borrowers go for the ARM loans they should have a thorough knowledge of how it works to avoid the worst.  Knowing the current market condition and knowledge of ARM programs are very helpful.

Currently fixed rates are very low. Most of the borrower are going for fix rates for the primary and the secondary residence. But for investment properties depending on the scenario ARM rates might be a better option.

The initial ARM rate is very low and but it is not always the case. It depends on the loan program you are going for. Fixed rates do not increase for the life of the loan. So, most of the first time home buyers almost always go with the fixed rate. When the fixed rate is not an option or if it is higher , people go for the variable rate. It keeps the rates low for first few years and make it attractive for borrowers. Many investors find ARM programs are the best in terms of the return on their investment.

For example , if you get an 5/1 ARM, the first 5 years the interest will remain the same. So, if you get a 3% rate it stays the same for first 5 years. Now, what happens after 5 years? The rate might increase. How much it can go up? 

The ARM program follows some guidelines. It has a margin, an initial rate, periodic rates and the cap. Your rate is always the margin plus the index rate. Usually , the initial rate is very low. Most of the ARM programs follow the LIBOR index. 

For the sake of an simplicity, assume that your margin is 2% and the LIBOR index is 1.5%, your rate will be 3.5%. For a 5/1 ARM the rate can change once in a year after the initial 5 year fixed period  is over. If  the LIBOR index is 3% after 5 years, your rate will be 2% margin plus 3%  LIBOR index that is a 5% rate after 5 years. In that case you are starting at 5% on the 6th year. 

Now ,if your loan has a cap of 5, it means it can’t go over the cap. The highest limit of the cap is your initial rate plus the cap. For example, when you took the mortgage , your initial rate was 3% and your cap is 5%. It means your rate can never go more than (initial rate 3 plus cap 5) 8% throughout the life of your loan. 

As a borrower you need to understand the cap structure of an ARM. As an example you could see a cap structure 5/2/5. What does it mean? This structure tells how an interest rate can change at different times. The first number says that after the initial fixed period period your interest can increase maximum by 5%. If initial rate is 3% fixed for 5 years, the first change after 5 years might increase up to 3+5=8% max. the 2nd number on this structure means the rate might increase 2%  every year periodically, it cannot increase more than 2%. The 3rd number (5) indicates the lifetime maximum change that might happen. So, if your initial rate is 3% , your rate can never go more than 8% , because your lifetime cap is 5.

Choosing ARM helps you keep your rate low initially. It all depends on your scenario for what types of mortgages would be good for you  Many borrowers are thinking off paying off their mortgages earlier may choose ARM when they see their saving on interest comparing to the fixed mortgage. For example , if you are buying a multi-family investment or commercial property ARM loan programs might be better for you. Some ARM programs have an interest only option very popular to many investors. 

The bottom line is that you go for the ARMs when you get advantages out of it. That said as long as  fixed rates are low , for most of the people the fixed rate programs would be more suitable when they buy their first or 2nd homes.For some investment properties fix rates might be an option as well.

Knowing about ARM loan programs , the way rates are calculated are important to avoid the worst. An investor should have a clear understanding of ARM loan terms in order to avoid unnecessary pitfalls. If you are going for fixed loan program , there are multiple options. So choose the one that gives less closing costs, less mortgage insurance and above all the lowest rate.