What is an Adjustable Rate Mortgage?
Mortgages are sometimes difficult to understand and if you don’t know what you’re getting into, you could end up hurting yourself in the long run. Adjustable Rate Mortgages, or ARM, are one of the various types of mortgages available for home buyers.
An adjustable rate mortgage, or ARM is different from a fixed rare mortgage in that the interest rate fluctuates during the loan duration. Normally, with an adjustable rate mortgage, rates are adjusted annually, although this can vary depending upon the lender and circumstances.
The way the ARM interest rate fluctuates depends upon certain interest rate indexes such as The London Interbank Offered Rate Index (LIBOR) or the U.S. Treasury Bill. As these index rates go up or down, the rates of the ARM are likewise affected. If you have an ARM for your home loan, this will affect your monthly mortgage payments.
Choosing an Adjustable Rate Mortgage depends upon what you are looking for and what you will be able to afford. Because the interest rate can go up and down, this means your mortgage payments will also go up and down. You will want to make sure that your ability to make your mortgage payments will not be affected if the interest rates should climb.
Unfortunately, many borrowers who had Adjustable Rate Mortgages were not prepared for an interest rate increase, and therefore were not expecting their mortgage payments to rise. As a result of such increases, many have been forced to sell their homes.
The good news, however, is that with an ARM your monthly mortgage payments will also decrease when the rates lower. As long as the rates are remaining low, so are your monthly mortgage payments. This is a nice way to avoid refinancing if your payments were becoming a bit steep.
The beginning interest rate on an Adjustable Rate Mortgage is usually lower than the interest rate on a fixed rate mortgage. Lower beginning interest rates will give you the ability to borrow more money, while still being able to keep the monthly payments manageable. This could mean the difference between a fixer-upper and that nice little three bedroom with a pool you just fell in love with.
Adjustable Rate Mortgages offer lower beginning interest rates because you, as the borrower, are taking the risk that the interest rate could adjust to higher levels. As always, be sure you read and understand all the information in your loan documentation. You need to know exactly how much the interest rate can rise before agreeing to the terms.
You should always ask, or carefully look for the interest rate caps on your loan. A cap is the set limit the interest rate can rise in a given time. There are two types of caps that the ARM may contain; a Periodic Rate Cap and a Lifetime Rate Cap.
Periodic Rate Cap:
This cap can rise to its limit each time in its cycle. The cycle time may vary but is usually around one year. With this type of cap, your interest rate can only be raised by that percentage (no matter how much rates may have risen in that given cycle) in that given time.
Lifetime Rate Cap:
This cap will set a maximum rate limit for the lifetime of your loan. During that time, the interest rate can never go beyond the rate set forth in the loan terms.
Another benefit of the ARM for those homeowners who are not looking to stay in their new homes for long term is that the period for the introductory rate is fixed for a determined number of years. After that introductory period, the rate will then be adjustable.
This is a nice way to enjoy the benefits of the adjustable rate mortgage and then sell the home before the introductory time expires for a nice profit.