An adjustable rate mortgage, also known as an ARM, is a mortgage that has the interest rate changed periodically based upon a pre determined index. The interest rate reflects the lender's cost of money and could be tied to, for instance, CD rates, T Bills, the 11th District Cost of Funds, 6 Month Libor - and so on. With an ARM, as the index rate climbs, the borrowers mortgage payments increase after a fixed period of time. As the index rate falls - the borrower's mortgage payment decrease.
ARM s are popular with both lenders and borrowers. They are popular with borrowers because the interest rate is usually lower than fixed rate loans and, therefore, help qualify the borrower for a larger loan amount. Adjustable rate mortgages are popular with lenders because they shift the risk of interest rate fluctuations from the lender to the borrower. Thus - the popularity of the ARM with lenders is one of the dangers that exist for ARM borrowers. The lower interest rate appeal of the ARM can quickly change to a financial disaster if index rates climb faster than the borrower's finances can accommodate them.
An ARM has 6 primary elements to be considered if you are evaluating this type of loan.
- Index - This is the base rate used by the lenders to determine future changes in the borrower's interest rate. Lenders try to use an index that will reflect fluctuations in the cost of money as determined by the state of the national or global economy. It makes sense to look at the index used by the lender and then review how sharply that index has risen or fallen over preceding periods.
- Margin - This is the difference between the interest rate published by the index and the rate charged to the borrower. The margin will not change throughout the term of the loan except in the case of a "teaser rate."
- Teaser Rate - Teaser rates are reduced introductory rates offered during the first year of the loan. Obviously, a teaser rate is meant to motivate the borrower into selecting a variable rate loan or selecting the lender offering the first year teaser.
- Rate Adjustment Period - The rate adjustment period defines the intervals at which the borrower's interest rate can be adjusted to reflect changes in the lender's cost of money. Depending upon the type of ARM you acquired from the lender, the interest rate adjustment period could be 6 months, a year - or perhaps even longer.
- Interest Rate Cap - The rate cap is the maximum number of percentage points your interest rate can increase over the life of the loan. Thus, even though your rate paid is variable - there is upward protection for the borrower in the event of runaway index rates due to a highly inflationary economy or other influence.
- Conversion Option - A conversion option comes into play for convertible ARM s. This option allows the borrower to convert the ARM to a fixed rate loan… usually during a defined time frame built into the original loan agreement. For instance, the borrower may be able to convert their ARM between the end of the second year and the end of the fourth. Convertible ARM s usually carry a higher initial interest rate - though lower than a fixed rate loan - when they are originated. The convertible ARM allows the borrower to qualify and have lower initial monthly payments - but to still take advantage of changing interest rates later on - or to limit the upside cost of the loan.
There are many different types of ARM s - some having different rate adjustment periods from the mortgage payment adjustment period. Ask you loan counselor about some of the ARM options that might be available to you.
|
|
Get a Quote
Calculators
Credit Check
|
