Adjustable Rate Mortgages
There are two types of mortgages that people may consider when they are trying to get a mortgage
. The ARM is one that many consider and is short for an adjustable rate mortgage. It is linked directly to the economic index. As this index is modified your interest rate is also modified which effects your payment amounts directly.
ARM Terminology
ARMs are linked to a specific index of the many that lenders use. The index is measure that lenders will use to note changes in the interest rate. Some of the most common indexes include the one, three, and five year Treasury securities.
Margin
The margin, also commonly thought of as lender's markup, is an interest rate. It is represented by the profit the lender makes on the loan combined with the cost they incur by working with you. It gets added to the index and these two factors combined calculate your interest rate. The margin typically does not change during the loan at all.
Adjustment period
Your adjustment period is how much time goes between possible adjustments to your interest rate. There are two numbers in the ARM. Examples include 5-1, 3-1, and 1-1. The first number is how long your loan is guaranteed to stay at the rate you signed it at and the second is how often lenders can adjust your mortgage rate. Each of the figures above have a 1 in the second number which means that if the lender desires they can adjust your rate up or down each and every single year depending on the market conditions.
You may wonder why you should even consider an ARM if your payments have the possibility of going up every year. The main appeal of an ARM is that the initial period of the loan is lower than traditional fixed rate mortgages which provide you with a lower interest rate when you get the loan and may allow you to borrow a larger sum of money than you would with a traditional fixed rate mortgage.
The length of time you intend to own your home should also be a factor of consideration when it comes to deciding between a fixed rate mortgage and an adjustable rate mortgage. If you only intend on having it for a few years it is very likely that an ARM will suit you much better. You may also consider an ARM if your income is expected to raise in the future due to a higher paying job or rate increase at your current job. You will be able to afford higher payments if you have to later on in the loan.
There are some ARMS that have the ability to be converted to fixed rate mortgages for a fee but you have to weigh on whether or not the conversion fee will save you any money at all.
ARM Indexes
Each lender chooses which index they decide to use when determining the interest rate. You should choose the right lender and type of loan that works for you based on the index that you want to be used for your loan. It is advisable to select an ARM that uses an index which has been very steady in the past few years. The lender should be able to provide this information for you. If the index isn't enough of a decision point also take into account the margin rate as well to help you decide.
Discounted Rates and Buydowns
Some sellers that you come across when looking for a home will offer to pay a buydown fee. This gives the lender permission to give you a lower rate than the sum of the margin and index in order to entice you to buy their home if they're trying to get it sold quickly. Beware though that this rate will expire and if the ARM has been rising during this time period you may have a significant increase in the interest rate and consequently in the amount of your monthly payments as well.
Adjustable Rate Mortgages
Some sellers may also be ahead of the game here and will increase the asking price on their home with intentions of offering the buydown rate. They will not lose any money and you will be paying a higher price for your home as a result. You may not be saving any money at all with a lower introductory rate here.
Interest Rate Caps
ARMS have two different types of rate caps associates with them. They limit just how much interest you can be charged on your loan. Overall caps limit how much the interest is legally allowed to be increased during the entire duration of the loan and have been required since 1987. Periodic caps place a limit on how much the rate can be adjusted for each period. Not all loans have this so check to be certain with yours.
Payment Caps
An ARM with a payment cap typically does not have a periodic rate cap because it limits how much your monthly payment is legally allowed to increase every time it's adjusted.
Carryovers
An interest cap has the possibility to keep your interest down even if the index went up. The lender is allowed to carry this increase over to the next adjustment period so you are still affected by it.
Beware of Negative Amortization
When payments cover enough to pay interest plus some of the principal balance amortization occurs. Negative amortization is the opposite and occurs when payments aren't even paying on the interest. If this continues to occur you will continue to make payments but owe more and more even if you've been paying on it. This generally occurs when a payment caps stops your payments from going up over the interest amount.
The Bottom line
Lenders must inform you of all information pertaining to your mortgage when you decide to get one. If you have any questions be sure to ask so that you aren't surprised by anything that happens.
Lori English is a Los Angeles real estate agent, broker and internet business woman. As a web expert, she writes about LA homes for sale, as well as for other websites. With her experience, certificates, and degrees, she understands real estate, the internet business, and how to invest in properties.
by: Lori English
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