Adjustable Rate Mortgages Pros and Cons
Adjustable Rate Mortgages Pros and Cons are necessary to know for borrowers. To have a home you can call your own is everybody’s dream. It is the place where you feel comfortable, happy and at ease. To fulfill your dream of a house needs good planning and efforts. You have to seek a loan from reliable bank or financial institution which can provide it at affordable rate. You have to do an extensive homework before deciding on home loan.
Getting right home loans can save you thousands of dollars as interest, fees and other miscellaneous expenses. To choose the right home loan, you have to analyse your finances, income, your budget, investment strategy etc. To choose wisely, you have to understand various aspects related to loan. You ask key fact sheet from the lenders and compare fact sheets from various lenders. It tells you about total amount will have to pay back over the life of the loan, repayment amounts, fees and charges.
Many people take out a principal and interest home loan, you make regular payments against the principal amount borrowed as well as interest and is designed as to be repaid in full over the time period of the loan. Some choose for a number of different principal and interest loans that includes a range of features such as a redraw facility or an offset account. More the features a loan has the higher the cost will be. Here we will check adjustable rate mortgages pros and cons in detail.
After going through different options of which home is right for you and deciding on mortgage offers, one very important decision you have to make is between a fixed-rate mortgage and an adjustable-rate mortgage (ARM). In case of fixed-rate mortgage type of a loan, the interest rate and monthly mortgage payments remains the same throughout the life of the loan.
Whereas for adjustable-rate mortgage, as the name implies, an interest rate that starts out lower, but can fluctuate with the housing index rate. Here, we will go in details of what adjustable rate mortgages (ARM) are that will help you better decide what the right kind of home loan is for you. Now let’s check what is an adjustable rate mortgage?
Adjustable Rate Mortgages
Adjustable Rate Mortgage loans are very popular type of home loans as initial mortgage payments are low in comparison to fixed-rate mortgages. It makes home more affordable to borrowers. However, it is somewhat risky as interest rates fluctuate and it can rise.
Types of ARMs
Most of the ARMs have an initial fixed-rate period which is usually low rate. After that the rate fluctuates. For example for 3/1 ARM, the rate will remain unchanged for first three years. Here the first number represents initial years of fixed rate. The second number represents the time period in years after which the rate can vary. Other popular ARM loans are 5/1, 7/1 and 10/1.
Important Features of Adjustable Rate Mortgage
- Initial Interest Rate: This is the interest rate you will have to pay to begin with.
- The Adjustment Period: It is the time period for which interest rate for your loan will remain fixed. The interest rate is reset once this period is over and the monthly loan payment is recalculated.
- The Index Rate: Most lenders link index rate to vary ARM interest rate. There are varieties of indices; three indices among them are common: they are London Interbank Offered Rate (LIBOR), national or regional average cost of Funds Index (COFI) and the weekly constant maturity yield on one, three, or five year U.S. Treasury (CMT) securities. LIBOR is the most commonly used benchmark for ARMs.
- The margin: It is the percentage points and lenders add it to the index rate in order to determine ARM’s interest rate.
- Interest rate caps: Cap is a limit placed on the interest rate or monthly payment that can change at the end of each adjustment period. There are three most common types of caps known as periodic rate cap, lifetime cap, and payment cap. As the name suggests a life time cap is a limit on the interest rate that can rise over the life of the loan. Periodic rate change applies to rate change at any one time whereas payment cap is the limit on the amount of periodic payment.
- Initial discounts: Most of the lenders offer interest concessions for initial period as promotional offer, usually the interest rate offered is below the prevailing rate.
- Negative amortization: When the monthly mortgage payments are not big enough to pay the interest due on the mortgage and as such mortgage balance increases. This happens when the payment cap is very low to be equal to principal plus interest payment.
- Conversion: This is the agreement that allows the buyer to change over ARM to a fixed rate mortgage at some specified time.
- Prepayment: This is the agreement that makes the buyer to pay penalties or special fees if the ARM is paid off before time. Prepayment can be negotiated.
Should you choose Adjustable Rate Mortgage?
Before you decide to go for an ARM, make sure you have evaluated the maximum rates that can rise. You calculate the worst case scenario considering rates rise to the maximum cap limit and then decide if you can afford it. You get benefited with an initial rate that is significantly below market rates for 30-Year Fixed Rate Mortgages.
Though Adjustable Rate Mortgage is risky, you can go for it. It is recommended to have an ARM when interest rates are predicted to fall. In times of rising interest rates, it is likely that you will end up paying much more for an ARM than for a 30-Year Fixed Rate Mortgage. If you are buying a house for the first time and prefer to know what you will have to pay every month than you should opt for a fixed-rate mortgage home loan.
If you are to buy a home and wants to get an Adjustable Rate Mortgage loan, make sure you understand all the possible features and adjustable rate mortgages pros and cons. If you can afford to pay the maximum possible amount if the rate rises, it is worth taking the risk.