What is an ARM mortgage?
An Adjustable Rate Mortgage. This is exactly as it sounds — a mortgage that can adjust over periods of time. Typically, an ARM will have rate caps. This means that after a specified number of payments, the rate can only increase by a certain percentage, usually no more than 2%. There are also lifetime caps, usually 6%, which will indicate the highest possible rate for that particular mortgage. ARM mortgages are usually taken out by borrowers who plan to stay in the property a limited period of time, or by borrowers who need a lower rate to qualify for more mortgage money.
An adjustable rate mortgage (ARM mortgage) is a mortgage whose interest rate is linked to an economic index. The interest rates and your payments will be adjusted periodically as the index fluctuates. The index is a rule used by lenders to measure the changes in interest rates. A common index used by lenders measures the activity of one, three and five year Treasury securities. When applying for an ARM mortgage, you also need to consider the lender’s margin. This is in effect the lender’s markup; it is the lender’s cost of doing business and the profit they intend to make on the loan. There is also the adjustment period to consider. This is the period between interest rate adjustments. An ARM mortgage with annual adjustments means that interest rates can change annually. Interest rates for an ARM mortgage are lower than those of a fixed mortgage. Fixed rate mortgages have interest rates that remain the same over the life of the loan. A lower rate of interest means lower repayments; thi
With a fixed-rate mortgage, the interest rate stays the same during the life of the loan. With an adjustable-rate mortgage (ARM), the interest changes periodically, typically in relation to an index. While the monthly payments that you make with a fixed-rate mortgage are relatively stable, payments on an ARM loan will likely change. There are advantages and disadvantages to each type of mortgage, and the best way to select a loan product is by talking to us.
To determine the rate on your adjustable mortgage, you first need to understand how an ARM works. The following terms are integral to an ARM: Fully Indexed rate: The rate you must pay, barring any periodic caps, in order to fully amortize or pay off the loan. Margin : The fixed component of your ARM loan, constant throughout the life of the loan. Index: The variable component of your ARM loan, changes on a monthly basis. Examples of indices include the Cost of Funds (11th District), One Year Treasury, Monthly Treasury Average (MTA), 1 Year Treasury Average, CD, LIBOR, etc. INDEX + MARGIN = FULLY INDEXED RATE Example using the 1 Year Treasury: 1 Year Treasury Index = 4.170% Loan Margin = 2.50% Fully Indexed Rate = 4.170% (Index) + 2.50% (Margin) = 6.67%*** *** Most lenders will round the rate to the nearest 1/8% so the actual rate would be 6.625% You should be familiar with the following ARM terms: Teaser Rate (aka your loan’s start rate): The initial rate on your adjustable, prior to i
Lenders generally charge lower initial interest rates for ARMs than for fixed-rate mortgages. This makes the ARM easier on your pocketbook at first than a fixed-rate mortgage for the same amount. It also means that you might qualify for a larger loan because lenders sometimes make this decision on the basis of your current income and the first year’s payments. Moreover, your ARM could be less expensive over a long period than a fixed-rate mortgage–for example, if interest rates remain steady or move lower. With a fixed-rate mortgage, the interest rate stays the same during the life of the loan. But with an ARM, the interest rate changes periodically, usually in relation to an index, and payments may go up or down accordingly. Against these advantages, you have to weigh the risk that an increase in interest rates would lead to higher monthly payments in the future. It’s a trade-off–you get a lower rate with an ARM in exchange for assuming more risk. Here are some questions you need to
