An ARM Mortgage also known as adjustable rate mortgage is a
mortgage with an interest rate that is linked to an economic index. As the
index changes, the interest rate, and your payments, are periodically adjusted
up or down. The ARM mortgage is a close first cousin to the Fixed Rate
mortgage, but just a little riskier.
For homeowners who have a fairly tight monthly budget, and
who have a need for bigger house, and lower payment, the ARM mortgage is a more
affordable option.
When you set up your mortgage on an ARM,
the interest rate you have will only be set for a very short period of time,
normally only 6,9, or 12 months.
The interest rate will be re-evaluated at the
end of that period, and if the rates have increased based on the prime, your
interest rate will also increase; once again, for a short, set period of time.
The presence of an all time low interest rates during
today's economy are the benefits derived from this type of loan. For current
homebuyers, and homeowners who refinance, that equates to big savings.
Given below is the terminal used in the ARM Mortgage.
Index
The lenders measure of interest rate changes is known as an
index. Activities of one, three, and five-year Treasury securities are the
common indexes used by lenders, but there are many others. Each ARM mortgage is
linked to a specific index.
Margin
Imagine the margin as the lender's markup. It is an interest
rate that represents the lender's cost of doing business plus the profit they
will make on the loan.
In order to determine your total interest rate, the
margin is added to the index rate. All through the life of your home loan, it
usually stays the same.
Adjustment Period
The period in between potential interest rate adjustments is
known as the adjustment period. You may see an ARM described with figures such
as 1-1, 3-1, and 5-1.
The first figure in each set refers to the initial period
of the loan, during which your interest rate will stay the same as it turned
out on the day you signed your loan papers.
The second number is the adjustment period, showing how
often adjustments can be made to the rate after the initial period has ended.
The examples above are all ARMs with annual adjustments--meaning adjustments
could happen every year.
When interest rates are low, another great benefit to the
ARM Mortgage is that it allows you to build equity faster than with a standard
fixed rate mortgage.
But your opportunity for building equity quickly is greatly
diminished if interest rates begin to rise since more of the payment is
directed to the interest on the loan.
ARMs aren't as attractive as the fixed rate mortgage if you
fall into the category of the typical homeowner; but let's face it the typical
homeowner category seems to be shrinking.
The drawback to this type of loan occurs when interest rates
begin to rise. As the rate rises for the lending institution, it also rises for
you, the homeowner.
Today, there are developments on the ARM
base product, that allow homeowners to operate under an ARM
mortgage for a particular number of years, and then the loan converts to a
fixed rate mortgage.
There are also the ARMs that offer an interest only mortgage
option for a definite number of years, then it converts to a basic ARM mortgage
for a specified number of years, and then you have the option to convert the ARM
mortgage to an FRM.
If you don't take the time to fully research and understand
your mortgage options, the home mortgage product market can be very confusing,
and quite frustrating.
So many mortgage choices are made available by mortgage
industry that it's often very difficult for the average consumer to think about
all the options and make the wisest choice, simply because you need a spreadsheet
and calculator just to compare the options, never mind making a decision about
the best options.
Overall, you would most likely benefit from the standard ARM
mortgage that converts to a FRM if you are buying a home, and over the next 10 years,
your income level is expected to increase, or your expenses are going to
decrease significantly.
Not all the other complicated options still simply
benefit the average homeowner today.
Related Articles:
|
