Adjustable Rate Mortgages
Common Types of ARMs
The Interest Rate Cap
How Interest Rates are Determined
Negative Amortization ARMs
When Should You Choose an ARM?
Adjustable rate mortgages (commonly called ARMs) have allowed thousands of people to purchase a home when they might not have qualified for a fixed rate mortgage. This is because the initial, or beginning mortgage interest rate, is much lower than on a fixed rate mortgage loan.
Adjustable rate mortgages come in almost as many varieties as ice cream, so a smart borrower needs to examine every detail of the home loan before choosing. Your Mouse House Mortgage Counselor will help you decide first if an ARM is right for you - and if so, which is the best choice.
Common types of ARMs
The interest rate on an ARM is set to adjust as specific intervals. The length of that interval is just one of the features that varies from loan to loan. Here's a brief rundown on the most common types:
- 6 month
- 1/1 (adjusts annually)
- 3/1 (fixed for three years, adjust annually thereafter)
- 3/3 (fixed for three years, adjust every three years thereafter)
- 5/1 (fixed for five years, adjusts annually thereafter)
- 7/1 (fixed for 7 years, adjusts annually thereafter)
- 10/1 (fixed for ten years, adjusts annually thereafter)
The interest rate cap
The cap, or upper limit on your mortgage interest rate, also varies from loan to loan. Some have a lifetime cap, meaning that the day you sign you know the highest your interest can ever be.
Most have a limit on how much the rate can adjust at one time. Some home loans can jump as much as 2% in one adjustment, which could skyrocket your monthly house payments.
How interest rates are determined
Each ARM is tied to a financial index, and different mortgage companies use different indices. Before choosing an ARM, ask your Mouse House Mortgage Counselor about the index and how it has performed over an extended period of time. Although the past doesn't dictate the future, that will give you an idea of each index's stability and likelihood of changing.
On top of the index rate, the mortgage company ads a margin, or markup. This covers the mortgage company's cost of doing business and gives it a profit. The margin remains the same when the index changes.
As with any other mortgage loan, your credit scores and loan to value will play a part in the margin your company will charge. See Getting the Best Mortgage Rates for more information.
Negative Amortization ARMs
Some ARM's allow for negative amortization. Under this program, the monthly payment doesn't change, even when the interest rate charges. If interest goes up and your monthly house payment isn't high enough to cover all the interest, the shortage will be calculated and added to your home loan balance.
This loan could be very risky, because a borrower could lose all equity in his or her home, and actually end up owing more than the original purchase price after a short time.
When should you choose an ARM?
Since loan qualifications are based on the initial payment amount, a borrower can qualify to purchase "more house" than he might using a fixed rate home mortgage loan. This is the big draw that has led thousands into ARMs in recent years.
The theory is that if they wait until they can afford the "normal" payments on that dream home, its price will have risen as well, and they still won't qualify. For a person in an industry that offers regular pay increases, this strategy makes sense.
If the borrower doesn't see an increase in income, however, the results can be disastrous.
Another time to choose an ARM is when you know you'll be selling your home and moving within the set time frame. For instance, if the rate is fixed for 5 years and you know you'll want to sell in 3, the savings from an Adjustable Rate Mortgage can be an advantage - especially if you can invest the difference and save it for a down payment on your next home purchase!
Discuss your current needs and future plans with your Mouse House Mortgage Counselor. He or she will help you "do the numbers" and decide which kind of loan is best for you.
Mouse House Mortgage is a free service for people who are looking for a
mortgage loan with favorable rates, whether you have excellent credit or bad
credit. A friendly mortgage advisor will help you navigate your options and
access the best mortgage rates for your situation.
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