Adjustable rate mortgages have their benefits and should be considered depending upon your home purchase situation. Most lenders offer adjustable rate mortgages today.
If you fall into one of the categories below, then an adjustable rate mortgage may be right for you :
- Borrowers who do not plan to be in their home for more than 3, 5, 7, or 10 years.
- Borrowers who are looking for lower payment options than what fixed rates offer.
- Borrowers who want flexible payment options on a monthly basis (also see interest only).
- Borrowers who have diffuculty verifying income may find more loan options with an ARM.
The interest rate of an adjustable rate mortgage (ARM) changes at pre-designated times based on fluctuations in market interest rates.
ARMs have adjustment caps, which limit the amount an interest rate can change within a given time period. So, your rate cannot go through the roof after one adjustment. There is also a lifetime cap on the rate.
Adjustable Rate Mortgages have a loan term of 30 years, with a fixed introduction period that can range anywhere from 1 month to 10 years. Many borrowers choose a shorter fixed introductory period to obtain a lower start rate. In most cases, the introductory period matches the borrowers time range for how long they plan to be in the home. This means the mortgage will be refinanced or the property will be sold prior to the end of the introductory period. After the initial fixed period, it mortgage will adjust according to the new interest rate.
1 or 3 Month Adjustable Rate Mortgage. This type of mortgage is typically fixed for the 1st year. After the 1st year, the interest rate may change month or every three months. This is great for borrowers who need a low payment for the 1st year. These loans are offered mostly on COFI, MTA, COSI, or CODI indexes. They also typically have an interest only option with as many as 4 payment options each month. This type of loan is called an OPTION ARM and can be extremely beneficial to the right borrower. At the moment, Option Arms are very difficult to find and were once considered to be sub-prime loans. Many people financed their Dream Home with an Option Arm and then found themselves owing more than the home is worth.
6 Month Adjustable Rate Mortgage. This type of adjustable rate mortgage changes its interest rate every six months. When interest rates are anticipated to decline, this short term ARM often enables borrowers to secure lower rates on their mortgages. Interest only is another option.
1 Year ARM / 6 Month Adjustable Rate Mortgage There is an initial fixed rate for the first year, then changes to a adjustable rate for the remaining 29 years. Usually, this type of loan offers a lower initial rate than a 3 year ARM / 6 month ARM.
2 Year ARM / 6 Month Adjustable Rate Mortgage There is an initial fixed rate for a three year period, then converts to an ARM for the remaining 28 years. This type of loan offers a lower initial rate than a 5 year ARM / 6 month ARM.
3 Year ARM /6 Month Adjustable Rate Mortgage This loan offers an initial fixed rate for a three years, then converts to an ARM for the remaining 27 years. Usually, this type of financing offers a lower initial rate than a 5 year ARM / 6 month adjustable.
5 Year ARM / 6 Month Adjustable Rate Mortgage This loan offers an initial fixed rate for a five year period, then converts to an ARM for the remaining 25 years. This loan offers a lower initial rate than a 7 year fixed /6 month ARM.
7 Year ARM/6 Month Adjustable Rate Mortgage Offers an initial fixed rate for 10 years, then converts to an ARM for the remaining 20 years. Generally, this type of financing offers a lower initial rate than a 30 year fixed rate mortgage or a 10 yr ARM.
10 Year ARM/6 Month Adjustable Rate Mortgage This loan is very popular for borrowers looking for a combination of security with a lower rate than a 30 yr fixed rate loan. It offers an initial fixed rate for ten years, then converts to an ARM for the remaining 20 years. Generally, this type of financing offers a lower initial rate than a 30 year fixed rate mortgage.
The Option Arm loan program, which is also referred to as the negative amortized loan (Neg AM), has a low starting payment rate. Typically the starting rate is 1 to 2 percent. The initial monthly loan payment is calculated based on the starting rate, but the note rate will be calculated by adding the Index plus the Margin after the first one to three months. The payment remains the same for the entire year, and is only adjusted yearly on the anniversary date.
Since the interest charges may often exceed the monthly payment, the interest that is not paid is added to the loan balance. This increases the loan amount, rather than decreasing the loan balance as in a fully amortized loan. This is called negative amortization or an increasing loan balance.
These loans have been phased out for the most part over the past couple of years. At one time, many lenders offered this type of ARM. Now, they are hard to find. If you are looking to finance your dream home, this may not be the program for you.
Federal Reserve Consumer Handbook – Adjustable Rate Mortgages – This handbook us given to all borrowers who apply for an adjustable rate mortgage
Read our article about fixed rate mortgages