What you should know today about adjustable rate mortgages

What you should know today about adjustable rate mortgages

There are two main types of mortgages you will encounter when looking to buy a home. The first is a fixed rate mortgage loan, which has the same interest rate and monthly payment throughout the life of your loan. An adjustable rate mortgage (or ARM), on the other hand, will have changing interest rates and monthly payments throughout the life of the loan.

If you're the type of person who likes to keep things simple and predictable, you'll probably appreciate the security of a fixed rate mortgage. Still, if you don't mind having to pay a higher interest rate in the future, an adjustable rate mortgage can help you get started with a lower initial rate. The interest rate, and corresponding monthly payment, will then vary according to market conditions (specifically the index rates like the interest paid on United States treasury bills).

Before you commit to an adjustable mortgage, you need to become familiar with some very important terms, the periodic cap and the life cap. These terms represent the maximum increase you can experience in your interest rates. The periodic cap tells you how much your interest rate can increase in any given period (for example, six months). The life cap tells you the maximum interest rate and monthly payment you have to pay at any time during the life of your loan.

These numbers help you understand what you would face in the worst case scenarios. You need to be comfortable with what you might have to pay in the future, so be sure to understand the potentially higher future payments. See if you could really afford these maximum payments, and look at how your budget would be affected by these changes. By the way, your loan terms will tell you how often your interest rate will adjust. On some loans, this may happen every month, but it usually happens about every six months or so.

We do not recommend that you accept a loan that has no caps, since there is no telling what your future interest rate and mortgage payments might be! Instead focus on the maximum payments and make sure you're comfortable with these amounts. Of course, you can always choose to go with a fixed rate loan instead, though you will likely have to pay a higher interest rate (at least initially). You will be locked in at this rate (unless you can refinance) regardless of what happens to national interest rates.

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