Considering an adjustable rate mortgage? Be sure you fully understand the risks

When interest rates go up, it's common for some people to look into the idea of a variable rate mortgage

The appeal is the lower initial interest rate compared with a traditional 30 year fixed rate mortgage. The rate can change over time, and sometimes not to your advantage.

David Mendels is the director of planning at Creative Financial Concepts in New York.

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There is a lot more room on the upside than there is on the downside.

A housing market that already poses affordability challenges for buyers has led to a rise in interest rates. The median list price is up from a year ago.

According to the Federal Reserve Bank of St. Louis, the average fixed rate on a 30-year mortgage is 5.05%, the highest it has been in over a year.

As of late May, the Mortgage Bankers Association said that 9.4% of mortgage loans were made with an interest rate of at least 4%. That is lower than earlier in the month, but higher than in January.

The initial interest rate is fixed for a period of time. An ARM is riskier than a fixed-rate mortgage. If you use an ARM to purchase a home or to re-finance a loan on a home you already own, this is true.

There are a few things to know if you are going to explore anARM.

The name of theARM should be considered. The introductory rate lasts five years and after that the rate can change once a year.

There is an introductory rate of 3/1, 7/1, and 10 years on some loans.

Knowing when the interest rate could change and how often is important, but you need to know how much adjustment could be made and what the maximum rate could be.

Don't just think about a 1% or 2% increase. Is it possible that you could handle a maximum increase?

The margin is an agreed upon percentage point used by mortgage lenders to arrive at the total rate.

If the index is 1% and your margin is 2%, you will pay 3%. If the index is 2% after 5 years, your total would be 4%. 5% after five years if the index is at. The terms of your contract can affect whether or not your interest rate jumps.

There is a lot of variability in the specific terms as to how much the rates can go up and how quickly.

There are caps on the annual adjustment and over the life of the loan that come with anARM. It's important to understand the terms of your loan because they can vary.

• Initial adjustment cap. This cap says how much the interest rate can increase the first time it adjusts after the fixed-rate period expires. It’s common for this cap to be 2% — meaning that at the first rate change, the new rate can’t be more than 2 percentage points higher than the initial rate during the fixed-rate period.
• Subsequent adjustment cap. This clause shows how much the interest rate can increase in the adjustment periods that follow. This number is commonly 2%, meaning that the new rate can’t be more than 2 percentage points higher than the previous rate.
• Lifetime adjustment cap. This term means how much the interest rate can increase in total over the life of the loan. This cap is often 5%, meaning that the rate can never be 5 percentage points higher than the initial rate. However, some lenders may have a higher cap.

It makes sense for buyers to move before the initial rate period ends. It's wise to consider the possibility that you won't be able to move or sell because life happens and it's impossible to predict future economic conditions

Stephen Rinaldi is the president and founder of Rinaldi Group, a mortgage broker. You could be underwater on the house and unable to get out if the market corrects.

Rinaldi said that the amount saved with the initial rate can be thousands of dollars a year, so it's a good idea for more expensive houses.

The savings may not be worth it for a mortgage less than $200,000.