It is important to understand all the different types of mortgages available to you before you go shopping for a mortgage. And, one of the most popular mortgage types in the market are Adjustable rate mortgages. An Adjustable Rate is an interest rate that changes over the life of the loan, resulting in possible changes in the monthly payments, loan term, and/or principal. Some plans have rate or payment limits, so your payment cannot go above a fixed amount.
A variable-rate mortgage, adjustable-rate mortgage (ARM), or tracker mortgage is a mortgage loan with the interest rate on the note periodically adjusted based on an index which reflects the cost to the lender of borrowing on the credit markets. The loan may be offered at the lender’s standard variable rate/base rate. There may be a direct and legally defined link to the underlying index, but where the lender offers no specific link to the underlying market of index they can choose to increase or decrease at their discretion. The term “variable-rate mortgage” is most common outside the United States, whilst in the United States, “adjustable-rate mortgage” is most common, and implies a mortgage regulated by the Federal government, with limitations on charges (“caps”). In many countries, adjustable rate mortgages are the norm, and in such places, may simply be referred to as mortgages.
Among the most common indices are the rates on 1-year constant-maturity Treasury (CMT) securities, the Cost of Funds Index (COFI), and the London Interbank Offered Rate (LIBOR). A few lenders use their own cost of funds as an index, rather than using other indices. This is done to ensure a steady margin for the lender, whose own cost of funding will usually be related to the index. Consequently, payments made by the borrower may change over time with the changing interest rate (alternatively, the term of the loan may change). This is not to be confused with the graduated payment mortgage, which offers changing payment amounts but a fixed interest rate. Other forms of mortgage loan include the interest only mortgage, the fixed rate mortgage, the negative amortization mortgage, and the balloon payment mortgage.
When you get an ARM, two main factors determine the rate you pay: the index and the margin. The index is a rate set by market forces and published by a neutral third party. The margin is an agreed-upon number of percentage points that is added to the index to determine your rate.
A thorough mortgage shopper will run across a bunch of acronyms to denote various ARM indexes, such as COFI, LIBOR, MAT and CMT. Each index responds at its own peculiar pace to the economy’s ups and downs.
Indexes can be divided into two broad categories: those based upon rate averages and those based upon more volatile spot rates. There is some overlap between the two categories. ARMs indexed to average rates tend to move more slowly, in rather gradual steps, whether the markets are rising or falling. ARMs based on spot rates go up and down abruptly.
There are many different types of adjustable-rate mortgages (ARMs), including:
– A 2/28 loan (a 30-year loan with a fixed rate for the first two years and an adjustable rate for the remaining 28)
– Interest only loan (IO loan) in which you make interest only payments for a set time with no reduction in the
principal loan balance
– Option ARM (or payment option ARM) which allows you to choose among several payment options each
month during the first few years of the loan (could result in limited reduction of principal or possibly an increase in the loan balance) depending on the payment option you choose
An adjustable rate mortgage usually has a period at the beginning of the loan with a fixed rate. After this initial period, called the introductory period, the adjustable rate mortgage rate will be adjusted regularly, according to a planed schedule. The schedule of when the rate will adjust is agreed upon at closing. This can be as soon as one month or as long as 10 years.
Adjustable rate mortgages can be used in situations where the buyer is looking for a short-term loan. Perhaps a buyer is looking at a possible job change or will be leaving the country in a couple of years. These buyers can take advantage of the lowered interest rate offered on an ARM without worrying about the adjustment period.
Adjustable-rate mortgage refinance loans are a good choice if you:
Are planning to move in a few years (before the end of the initial rate period)
Expect your income to rise enough in the coming years to cover any increase in payments resulting from an increase in the interest rate
Want lower initial monthly payments than a fixed-rate mortgage usually offers
Think interest rates may fall in the future
Some disadvantages of adjustable-rate refinance mortgages:
-If you plan to sell the home before the introductory period ends, there is an element of risk, as it can be difficult to predict exactly how long it will take to sell your home
Interest rates will increase in a rising rate environment
-An increase in rates will increase your monthly payment amount, which may not keep pace with any increase in income
-An increase in interest rate will reduce accumulation of Glossary Term: equity Information Panel, especially where home values are declining, and may make it more difficult to refinance your loan again.