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Adjustable Rate Mortgages

Adjustable Rate Mortgage Benefits
How Can an Adjustable Mortgage Help Me?
Lower Monthly Mortgage Payments
Enable You To Make Interest Only Payments
Increased Savings Over 30 Year Fixed Loans

Adjustable Rate Mortgage Basics

Adjustable Rate Mortgages or (ARM’s) are loans whose interest rate can vary during the loan’s term. These loans have a fixed interest rate for an initial period of time (usually 3, 5, 7, or 10 years) and then typically adjust on a yearly basis. The initial rate on an ARM is usually going to be lower than than what is offered with a 30 Year fixed mortgage and can be advantageous if you plan on being in your home with a timeline of one to ten years.

Advantages Of An Adjustable Rate Mortgage

This lower interest rate can save you hundreds if not thousands of dollars in payments per month and over time usually performs better than a typical 30 year fixed rate mortgage. With an adjustable rate mortgage you do not have to pay for the ability to fix the rate for a full 30 years as you do with a 30 year fixed mortgage. You only pay for a fixed rate for as many years as you need it, no more.
Adjustable rate mortgages also give you the ability to make interest only payments. Interest only payments can significantly lower your monthly payment.

Adjustable Rate Mortgage Amortization

Adjustable rate mortgages are usually amortized over a period of 30 years with the initial rate being fixed for anywhere from 1 month to 10 years. All adjustable rate mortgages have a “margin” plus an “index”, which makes up the “fully indexed” rate. This is the end rate you pay expressed as 6.25% or whatever it turns out to be when your initial fixed period of 1 to 10 years has ended. Again, you choose how long this initial fixed period is. You make it only as long as you will need it, and therefore get a lower rate.

Margins on loans range from 1.5% to 4.5% depending on the index and the amount financed in relation to the property value, otherwise known as the “Loan to Value” of the home. The index is the financial instrument that the adjustable rate mortgage loan is tied to such as: 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD) and the 11th District Cost of Funds (COFI).

All You Need to Know About Adjustable Rate Mortgages

An adjustable rate mortgage, also commonly known as an ARM, is a kind of mortgage with interest rates determined by the economic index. The interest rates in the ARM continually adjust according to changes in the economic index. This sets an ARM apart from fixed rate mortgages where the interest rate remains the same during the entire life of the loan. Let us take a look at the adjustable rate mortgage in detail.

Features of Adjustable Rate Mortgages

The adjustable rate mortgage has four key features: the index, the margin, the initial interest rate period and the interest rate cap structure. Lender use the index in the ARM as a guide to track changes in the interest rates. The one, three and five year Treasury Securities are the most common indexes lenders use while determining the rate.

When the initial interest rate period expires, the new interest rate is determined by adding a margin to the index. The lender discloses the margin at the time of filing the loan application. These margins vary from lender to lender. This being said, you should shop around a bit to find lenders with lower margins. The interest rate is adjusted as per fluctuations in the index. The interest rate cap structure limits the fluctuations in the interest rates of your loan and protects you from unreasonable increases.

Benefits of Adjustable Rate Mortgages

The main benefit of an adjustable rate mortgage is the lower monthly payment. Banks provide this type of mortgage with a lower initial interest rate as borrowers take the risk of the interest rate increasing in the future. (This is in stark contrast with fixed rate mortgages where the bank takes the risk.) Also, lenders might consider extending your loan based on your current income or the first year’s payments. This way, an ARM can be less expensive than a mortgage with a fixed rate, especially if the interest rates are lower or move steadily over a period of time.

To know whether an adjustable rate mortgage is right for you, consider your current and projected income and be sure it is enough to cover high mortgage payments should there be an increase in the interest rates in the future.

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