What is an adjustable rate mortgage? There are many types of adjustable rate home mortgages. Adjustable rate mortgages, developed in reaction to extremely high interest rates years ago, have become popular...
Adjustable rate mortgages, developed in reaction to extremely high interest rates years ago, have become popular mortgage loan products. Qualifying for an adjustable rate mortgage is often easier than qualifying for products that are more traditional. Stephen Edwards of Waterfield Financial Company, the nation's largest privately owned mortgage company, states that a variety of adjustable mortgages exist in today's market.
The basic adjustable rate mortgage offers lower initial interest rates for a predetermined time. The interest rate is adjusted after that time and reflects the current rates that are being offered on the mortgage market. Both the lender and the borrower take a risk that the future interest rates will be acceptable to them.
"In a nutshell, they [adjustable rate mortgages] are typically fixed for a period of time immediately following the closing of the loan," says Edwards. He goes on to say that in most cases, the loan is probably fixed for one year. Then, after approximately twelve months, the adjustable rate mortgage, also referred to as ARM, adjusts its interest rate.
Edwards states, "Usually, most of them adjust annually." However, he notes that adjustable rate mortgages can adjust the interest rate after six months, one year, three years, or five years, depending on the predetermined conditions of the loan. Furthermore, he notes that ARMs that adjust after three or five years usually begin to adjust on an annual basis after that. Occasionally, some ARMs may adjust their interest rate on a monthly basis throughout.
Despite the differences that may exist, all adjustable rate mortgages are composed of four basic parts: initial interest rate, adjustment interval, index, and margin. The initial interest rate is generally one to three percentage points lower than the interest rate offered by fixed-rate mortgages. The adjustment interval is the time in between the beginning point of the loan and the change in the interest rate being charged. This period is predetermined at the origination of the loan.
The index is what the lenders use to determine the difference between what they are making on the ARM and what they could be making on an investment of a different type. The margin is an additional amount that the lender is allowed to add to the index to set the adjusted interest rate on the adjustable rate mortgage. Generally, this margin ranges between 1.5 and 3 percent.
Edwards notes that a variety of adjustable rate mortgages exist, "There are ARMs that are based on the US Treasury Market. There are ARMs that are based on London Based Rate, which is called Libor ARM (London Interbank Offered Rate)."
Adjustable rate mortgages come with certain safeguards for the borrower. An interest rate cap limits the amount that the adjusted rate can change. Additionally, a mortgage payment cap exists. This will limit the amount that the monthly mortgage payment may increase at a given time.
Adjustable rate mortgages are excellent choices for borrowers who fall into one of three categories. Typically, a homeowner who intends to finance a property for a short period before selling makes a good candidate for this type of loan. Additionally, a borrower whose income earning potential has not peaked yet may benefit from this type of mortgage loan. Finally, a market climate of extremely high interest rates puts the adjustable rate mortgage in a very beneficial light.
