Adjustable Rate Mortgages
Adjustable rate mortgages (ARMs) are one of the types of home mortgages that are the most sought-after by American consumers. Mortgage lenders play a pivotal role during the comparison-shopping phase by furnishing inquiring borrowers written information to assist them in understanding the various ARM loans and in choosing the one that best suits their particular situation. This article will shed light on and highlight the features of adjustable rate mortgages.
ARMs are mortgages with interest rates that are not fixed for the full term of the loan and that are determined by an economic index. Mortgage rates and borrowers' payments are regularly adjusted as the interest rate index changes. More specifically, ARM loans follow two phases: During the first phase, known as the "initial rate period", interest rates are fixed. The adjustable mortgage rates quoted by mortgage lenders or brokers are applicable until the end of the initial period, which typically lasts anywhere from one month to 10 years. Variable rates then kick in, sometimes carrying along with them higher interest. Usually, adjustable rate mortgages with low initial rates have shorter fixed-rate terms. All ARM loans are linked to specific indexes, which are guides that mortgage lenders rely upon to measure fluctuations in the interest rate. Borrowers should ask their lender which index applies to a specific ARM and how it has performed recently. They should select ARM loans that are linked to indexes that have demonstrated long-term stability. Such data concerning indexes is also available online and in numerous periodicals.
Other important information that borrowers should gather from their mortgage lenders when making a decision about an ARM are the following:
1. The current fully indexed rate:
The total interest rate, or fully indexed rate, is computed by adding the margin to the index rate's most recent value. The margin can be considered the creditor's markup; it is the interest rate that reflects the lending institution's cost of doing business as well as the profit they expect to earn on the loan.
2. Rate adjustment cap:
Rate caps limit the interest rates that lenders can charge. Two types of rate caps are associated with adjustable rate mortgages:
- Overall caps, which limit the size of any interest rate increase over the loan's term. This law has been in effect since 1987.
- Periodic caps, which limit the size of any interest rate increase from one adjustment period to the next.
Most ARM loans have rate adjustment caps.
3. Payment adjustment cap:
Regardless of how much the interest rates change, a payment cap places a ceiling on the lender's increase of the monthly payment at each adjustment. Adjustable rate mortgages that contain payment caps usually do not have periodic caps.
4. The loan's initial period and adjustment period:
Borrowers will notice that ARM loans display two figures (i.e. 4-1, 3-1, 1-1). The first number in each set represents the duration of the loan's initial term of the loan, during which interest rates remain constant. The second number refers to the adjustment period, which denotes the authorized number of adjustments that mortgage lenders can make to the rate upon termination of the initial period.
Finally, borrowers should keep in mind that the initial interest rate on ARM loans is less than that on fixed-rate mortgages. Because the initial monthly mortgage payments on the real estate in question are lower on an ARM, it is easier for consumers to qualify for this type of loan and for a larger amount than with a fixed-rate mortgage. The potential for rate increases will not be much of a concern to borrowers who intend to sell their home in the near future. Furthermore, individuals who anticipate an increase in their income will be able to use those extra funds to meet the higher payments flowing from any rate increase.
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