Adjustable-rate mortgages, also called ARMs have a fluctuating interest rate based on several current market factors. The terms of the mortgage will spell out how often and how much the interest rate can change over the life of the loan.
ARMs typically have lower introductory interest rates than fixed-rate mortgages, making them appealing to one who doesn’t plan to own their home very long before selling.
Key factors to consider when deciding on an ARM include how long you plan to own the home and how frequently payments may change. If you plan to stay in the home for a long time then you might be better off with the stability of a fixed-rate mortgage.
Adjustable-rate mortgages consist of three primary components: an index, margin and calculated interest rate.
The index rate is based on an index that measures the lender’s ability to borrow money. The specific index used can vary; one example is US Treasury Bills. Indexes cannot be controlled by the lender.
The margin is also known as the spread. It is a percentage added to the index to cover the lender’s overhead and profit. Though the index can rise and fall over time, the margin usually remains constant over the life of the loan.
The calculated interest rate is figured by adding the index and the margin together. This is the new rate the homeowner will pay.
The interest rate for adjustable rate mortgages change with fluctuating market conditions; therefore, it is a good idea to understand your adjustment period. The introductory interest rate is often very low and the adjustment period may be shorter than future adjustment periods. Rates can change every 6 months or every year. Structure can vary from one lender to another with ARMs.
Rate caps protect homebuyers from dramatic increases in the interest rate. Most ARMs have caps that limit how much the rate may rise between adjustment periods as well as how much it can increase or fall over the life of the loan.
Payment caps are built into some ARMs to place a limit on how much your monthly payment can increase during an adjustment period. This can create a problem if the interest rate increases to the point that monthly interest exceeds the monthly payment. This creates negative amortization, which means your mortgage balance goes up each month that you make only the minimum required payment.
If you are considering an adjustable-rate mortgage, be sure to talk to your lender and get answers you need so you understand the financial impact of this choice.
Mark Goedert of Goedert Real Estate provides valuable information to first-time homebuyers so they can educate themselves to make wise financing decisions. The type of financing and terms of your mortgage will depend on your individual needs and circumstances.
Mark Goedert of Goedert Real Estate has been in business for over 50 years, working with real estate professionals, agents, developers, investors, REO brokers and first-time home buyers in Mason, Hudson, Pinckney, St. Clair Shores, Bedford, Southfield, Saline, Canton, Trenton and neighboring cities and communities in the Down River Area.
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