Other Types of ARMs

There are many varieties of ARMs, and new ideas are introduced all the time. However, in the following more common variations, you'll recognize the fundamental characteristics we've already seen.

Hybrid ARMs

These loans, which we touched on earlier, have become popular for the same reasons we've already explored. First, they typically carry a lower initial rate than FRMs. And second, they do so for more than one year. A 5/1 ARM or a 7/1 ARM means that the loan holds its initial interest rate for five years or seven years (there are other lengths, too, such as 3/1 and 10/1).

Sometimes called multi-year ARMs, these loans do not generally carry as low a rate as the 1/30 or 1/15, simply because the lender cannot adjust the rate as frequently as market conditions change.

For the buyer who plans to move within the loan's initial lower-rate period (5 years or 7 years, for example) these newer type loans are worth serious consideration, chiefly because they can work out cheaper than FRMs, and offer stable payments for an extended period (not just for one year, like other ARMs).

With a 7/1 ARM, after seven years the loan turns into a one-year ARM for the rest of its life, and can then adjust annually, just like a1/30 or 1/15 ARM. All hybrid ARMs work this same way

Caution: Ask your lender (then confirm with your attorney) if there is an early pay off penalty clause with any loan of this type—and what it means.

Convertible ARMs

As the name implies, this loan allows the borrower the option of converting to a FRM at some future point. Commonly the fee for converting can range from $250 to $600, but that certainly beats the thousands of dollars a refinancing would cost. A Convertible ARM'S initial rate is always lower than the conventional FRM. And the restricted period in which the switch over to a FRM can be made is always specified in the loan's terms and conditions. Typically, you cannot make the switch within the first year, nor after the fifth year,though this can vary.

Converting would make sense only if, during the allowed period, you can take advantage of a lower FRM rate, which would reduce your monthly payment. Naturally, if the FRM rate remained higher you would stay with your ARM'S lower interest rate. In practice, convertible ARMs do not typically convert to the current FRMrate, but to a rate about 0.25 percent higher.