Adjustable Rate Mortgages (ARM)
These loans generally begin with an interest rate that is 2-3
percent below a comparable fixed rate mortgage, and could
allow you to buy a more expensive home.
However, the interest rate changes at specified intervals
(for example, every year) depending on changing market conditions;
if interest rates go up, your monthly mortgage payment will
go up, too. However, if rates go down, your mortgage payment
will drop also.
There are also mortgages that combine
aspects of fixed and adjustable rate mortgages - starting
at a low fixed-rate for
seven to ten years, for example, then adjusting to market conditions.
Ask your mortgage professional about these and other special
kinds of mortgages that fit your specific financial situation.
Most adjustable rate loans (ARMs) have a low introductory
rate or start rate, some times as much as 5.0% below the current
market rate of a fixed loan. This start rate is usually good
from 1 month to as long as 10 years. As a rule the lower the
start rate the shorter the time before the loan makes its first
adjustment.
Index - The index of an ARM is the financial
instrument that the loan is "tied" to, or adjusted
to. The most common indices, or, indexes are the 1-Year Treasury
Security, LIBOR
(London Interbank Offered Rate), Prime, 6-Month Certificate
of Deposit (CD) and the 11th District Cost of Funds (COFI).
Each of these indices move up or down based on conditions of
the financial markets.
Margin - The margin is one of the most important aspects of
ARMs because it is added to the index to determine the interest
rate that you pay. The margin added to the index is known as
the fully indexed rate. As an example if the current index
value is 5.50% and your loan has a margin of 2.5%, your fully
indexed rate is 8.00%. Margins on loans range from 1.75% to
3.5% depending on the index and the amount financed in relation
to the property value.
Interim Caps - All adjustable rate loans carry interim caps.
Many ARMs have interest rate caps of six-months or a year.
There are loans that have interest rate caps of three years.
Interest rate caps are beneficial in rising interest rate markets,
but can also keep your interest rate higher than the fully
indexed rate if rates are falling rapidly.
Payment Caps - Some loans have payment
caps instead of interest rate caps. These loans reduce payment
shock in a rising interest
rate market, but can also lead to deferred interest or "negative
amortization". These loans generally cap your annual payment
increases to 7.5% of the previous payment.
Lifetime Caps - Almost all ARMs have a maximum interest rate
or lifetime interest rate cap. The lifetime cap varies from
company to company and loan to loan. Loans with low lifetime
caps usually have higher margins, and the reverse is also true.
Those loans that carry low margins often have higher lifetime
caps.
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