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Adjustable Rate Mortgages (ARM)An Adjustable Rate Mortgage is a mortgage whose interest rates is raised or lowered at periodic intervals according to prevailing interest rates in the market. Also called Variable-Rate mortgages. Adjustable rate mortgages allow the interest rate on a home loan to fluctuate during its life. When financial markets are unstable, adjustable rate mortgages can be risky for home owners because the rate can increase with little notice. On the other hand, this type of mortgage may allow the borrower to purchase a more expensive home. To get started immediately, click here for our online application. Adjustable-rate loans vary, but they all share one common factor -- some aspect of the terms of the loan can be changed by the lender during of payment, or length of time for repayment. If you are considering applying for any type of adjustable-rate loan, make sure you understand exactly how the mortgage works, including the spread between the interest rate and the index to which the rate is tied; how often the loan can be adjusted; the maximum allowable increase (or decrease) each year as well as over the life of the loan. Adjustable Rate Mortgages The specific type of adjustable mortgage is tied to whether the change is in the rate of interest, amount ARMs. These loans typically offer a lower interest rate than fixed-rate loans to begin, and often come a lower-than-market interest rate in the first year. The future interest rate, after the initial period, will usually be adjusted annually and is tied to an index that may move up or down but is not under the control of the lender. The index might be the one-year Treasury bill (the "T-bill" rate) or some other rate that reflects the changes in interest rates. Note that the rate is tied to the index -- it is not the same as the index. The mortgage might specify, for example, that the future rate would be two points above the average T-bill rate. Typically, ARM’s are adjusted once a year on the anniversary date of the loan. Additionally, ARM’s usually have a provision for a cap, that is, the highest rate that could be charged. Some may include a minimum rate as well. When considering ARMs, consumers should never take one without a cap, and should insist on an example of what the highest possible payment would be under a particular ARM. These loans usually offer a conversion factor that allows the borrower to convert to a fixed-rate loan at a specified period of time. For example, a convertible ARM could allow the borrower the option to convert to a fixed-rate loan once a year over the first five years of the loan. The interest rate to be paid would also be tied to an index. Renegotiable-rate mortgage (rollover) These loans typically set the interest rate and monthly payments for several years, sometimes as if the loan were being amortized over a much longer period, and then allow both the rate and principal payments to be changed depending on general market conditions. If the new terms are unacceptable to you, you can pay the loan in full or refinance at prevailing interest rates. Graduated payment mortgage (GPM) With this type of loan, typically sought by young buyers who expect their incomes to rise, the payments are low in the first couple of years and gradually set to rise for five the years thereafter. These loans offer lower-than-market rates of interest and low payments in exchange for a lender’s share in appreciation of the property. Usually, the lender will require that its share of equity will be turned over when the home is sold or at a specified date set out in the loan agreement. Several Adjustable Rate Mortgages, ARMs, are available to homeowners and they include 6-Month Certificate of Deposit ARM, 1-Year Treasury Spot ARM, 6-Month Treasury Average ARM, and the 12-Month Treasury Average ARM. An ARM that reacts quickly to the market will allow the borrower to benefit from falling interest rates. An ARM that lags behind the market will allow the borrower to take advantage of lower rates when rates being to increase. As a borrower it is important to watch the market and speak with your mortgage broker to decide which type of ARM will best fit your home loan needs. There are several aspects of ARMs that impact interest rates including the index, margin, interim caps, and payment caps. The index of an ARM is the financial instrument that the loan is linked to and indexes move up and down with the market. The margin is added to the index to determine the interest that the borrower will pay. Caps, such as the interim cap, protect borrowers against rising interest rates. Payment caps, on the other hand, place a maximum on the amount a borrower must pay. This type of cap also protects against payment shock associated with rising interest rates. The index of an ARM is the financial instrument that the loan is "tied" to, or adjusted to. The most common indices, or, indexes are the 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD) and the 11th District Cost of Funds (COFI). Each of these indices move up or down based on conditions of the financial markets. The margin is one of the most important aspects of ARMs because it is added to the index to determine the interest rate that you pay. The margin added to the index is known as the fully indexed rate. As an example if the current index value is 5.50% and your loan has a margin of 2.5%, your fully indexed rate is 8.00%. Margins on loans range from 1.75% to 3.5% depending on the index and the amount financed in relation to the property value. All adjustable rate loans carry interim caps. Many ARMs have interest rate caps of six-months or a year. There are loans that have interest rate caps of three years. Interest rate caps are beneficial in rising interest rate markets, but can also keep your interest rate higher than the fully indexed rate if rates are falling rapidly. Some loans have payment caps instead of interest rate caps. These loans reduce payment shock in a rising interest rate market, but can also lead to deferred interest or "negative amortization". These loans generally cap your annual payment increases to 7.5% of the previous payment. Almost all ARMs have a maximum interest rate or lifetime interest rate cap. The lifetime cap varies from company to company and loan to loan. Loans with low lifetime caps usually have higher margins, and the reverse is also true. Those loans that carry low margins often have higher lifetime caps. |
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