Adjustable Rate Mortgage
Literally millions of people have been able to realize their dream of home ownership thanks to Adjustable Rate Mortgages (ARMs). Nothing keeps people off the property ladder quite like high interest rates and for this reason ARMs were introduced to favor the borrower and at the same time protect the lender.
An ARM works by offering people an introductory low interest rate even in times of high interest levels. Once the initial period of low interest expires the rate rises to reflect market conditions. How much the rate rises by will depend on market forces and will be adjusted periodically (up or down) in line with economic index changes.
More...Adjustable Rate Mortgage Benefits
ARMs are an excellent financing option during times of high interest rates, offering people a period of grace in which to find their feet before more realistic levels of interest take effect. In addition to this, people with rising income expectations find ARM an ideal way of financing property as do those looking for short-term home ownership.
While adjustable rate mortgages have their advantages there as some key conditions that cannot be overlooked. It is likely payments and interest rates will increase – sometimes dramatically as well as irregularly – therefore property owners must be confident their income will be enough to cover repayments.
Adjustable Rate Mortgage Risks
Low mortgage interest rates for the first year or two can be wonderful but higher repayments are sure to follow just as night follows day. It is often tempting to take on an adjustable rate mortgage hoping something comes up in time for the rates rise, ie a higher paying job. Other people take on an ARM with the intention of refinancing when the period of low interest expires. In fact, some consumers have been wrongly advised to do just that only to find they are prevented from refinancing.
One of the most common reasons people cannot refinance is prepayment penalties. Lenders almost always enforce penalties after the first rate adjustment to prevent consumers ‘jumping ship’ when the rates rise.
Top Three Types of Adjustable Rate Mortgage Loan Products
5/1 ARM loans
Payments are fixed for five years and adjust for remaining 25 years.
3/1 ARM loans
Payments are fixed for three years and adjust for remaining 27 years.
2/1 ARM loans
Payments are fixed for two years and adjust for remaining 28 years.
ARM First Payment Adjustment
The initial interest rate on your Adjustable Rate Mortgage will vary depending on your circumstances – such as income and credit score – and loan provider.
The interest during the introductory period is not linked to an economic index but is agreed by the lender. After the adjustment, however, your new repayment will be index linked with an additional margin on top. You may find your loan has a higher increase for the first payment adjustment than for subsequent payments – some go as high as the maximum cap rate. Depending on what your cap rate is, this jump could represent as much as another 5 to 6 percent.
For example:
Let’s say you borrowed $300,000 at an initial rate of 4% and pay $1,432.25 per month for principal and interest. If your rate moved to 6.5%, your payment would increase to $1,896.20, or about $464 more a month. If your rate moved to 9%, your payment would be $2,413.86, or a difference of an additional $982 a month.
If this scenario gives you the cold sweat, you’re not alone. Few homeowners can afford this kind of rise in monthly payments. Therefore it is important to understand your options.
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