Understanding Adjustable Rate Mortgages
Today's mortgage market place is changing with the advent
of adjustable rate mortgages. Almost one third of applicants
are now choosing ARMs over traditional fixed rate mortgages.
While ARMs aren't necessarily a new addition to the market,
lenders are offering new variations of the loan and offering
affordable solutions for most homebuyers. From hybrid
loans to indexes and margins, there is a lot of information
to account for in order to make a responsible loan decision.
Adjustable Rate Mortgage vs Fixed Rate Mortgage
Adjustable rate mortgages, or ARMs, are one of two main
types of home
mortgage loans. An adjustable rate mortgage will change
over the life of the mortgage loan as market interest
rates move up and down. However, these typically start
with a fixed interest rate for an allotted period then
move to an adjustable rate for the remainder of the loan
term. Lenders reward loan applicants for taking on the
risk of high future rates by offering lower rates during
the fixed period. This can be as short as a year or extend
up to 3, 5, 7, or 10 years. A fixed rate mortgage is practically
the opposite of an ARM. It can be defined simply as a
mortgage loan that has a guaranteed fixed interest rate
for the duration of the loan. Common fixed interest
rates loan include a 30-year fixed rate mortgage,
15-year fixed rate mortgage, and biweekly mortgages.
Adjustable Rate Mortgage Loan Types
Popular fixed-rate/variable-rate loan cycles include the
3/1 ARM, the 5/1 ARM, the 7/1 ARM, and the 10/1 ARM. The
first figure represents the number of years the loan will
be fixed followed by annual adjustments thereafter. So
in the case of a 3/1 ARM, the loan will have a 3-year
fixed rate then adjustable rates thereafter. After the
fixed-rate period is over the adjustable-rate will begin
and is determined by an index the rate is linked to. The
most common indexes are the weekly constant maturity yield
on the one-year Treasury Bill, the 11th District Cost
of Funds Index (COFI), and the London Interbank Offered
Rate (LIBOR). In addition to the index rate, lenders often
include margins to determine what rate you pay. The margin
is a number of percentage points added to the index to
calculate your rate. Another feature put in place to protect
the borrower from extreme changes in rates is the rate
cap. Rate caps and payment caps basically limit the amount
that your rate or payment will change. The most common
caps are lifetime caps, payment caps, and periodic rate
caps. Lifetime caps are put in place to limit how much
interest can rise during the lifetime of the loan. Payment
caps will limit how much monthly payments rise over the
life of the loan and are usually measured in dollars rather
than percentage points. The periodic rate cap is put into
place in order to limit the amount of percentage points
that change over a certain period. Typically, with precautionary
measures in place, homeowners should be protected from
drastic changes in index rates. However, interest rates
are rising and some homeowners are choosing home
mortgage refinance to switch over to stable 15-year
and 30-year fixed rate mortgages. Staying up to date with
the latest market news and index rates will keep you prepared
and in a good position to make an informed loan decision
when it's necessary. |
