Which would most likely have a higher payment over the first

Which would most likely have a higher payment over the first year a 3/1 ARM or a 30-year mortgage? Which one is riskier? Why?

Solution

A 3/1 ARM is a mortgage in which the interest rates are fixed for the first three years, followed by periodic readjustments of the mortgage interest rate. The readjustment intervals are pre-determined and usually tied to a financial index, thereby moving up or down with the value of the same. Further, the adjustable interest rate has an upper cap, therefore protecting against the risk of a substantial rise in the value of the reference index(and therefore of the adjustable interest rate). The borrower would opt for such a loan as it usually has a lower initial fixed rate (for the first three years) as compared to a 30 year fixed rate mortgage. The borrower trades off the lower initial three years fixed interest rate in return for exposure to a potentially higher adjustable rate for the remaining period of the loan tenure. This type of loan is suitable for people with high expectations of rising income in the future. Understandably, the ARM is the riskier of the two mortgage types mentioned in the question as an ARM borrower faces the potential risk of very high adjusted mortgage interest rates.