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Adjustable Rate Mortgages |
Typically more that 60% of homeowners have ARMS.
How ARMS Work:
THE BASIC FEATURES The Adjustment Period with most Arms is the interest rate and the monthly payment changes in variables of every month, year or every three to five years.
The period between one rate change and the next is called the "adjustment period."
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A loan with an adjustment period of one year is called a one-year ARM, and the interest rate can change once every year. Most lenders tie ARM interest-rate changes to changes in an "index rate." These indexes typically vary up and down. |
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Payment Fluctuations:
If the index rate increases, your mortgage rate will increase and in turn your monthly payment will increase in that month, year and/or adjustable period.
If the index rate decrease, your mortgage rate will decrease and in turn your monthly payment will decrease in that month, year and/or adjustable period.
Types of Indexes:
Lenders base ARM rates on a variety of indexes.
Their are a variety of indexes concerning the ONE, THREE, or FIVE-YEAR Treasury Securities.
Another common index is the National or Regional Average Cost of Funds to savings and loan associations.
A few lenders use their own cost of funds as an index, which gives them more control than using other indexes. You should ask what index will be used and how often it changes.
Also ask how it has fluctuated in the past and where it is published, we have booklets on this subject if you are interested in knowing more.
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The Margin to determine the interest rate on an ARM, lenders add to the index rate a few percentage points, called the "margin." The
amount of the margin may differ from one lender to another,
but it is usually constant over the life of the loan. |
Index
Rate + Margin = ARM Interest Rate
Let's say, for example, that you are
comparing Arms offered by two different lenders. Both Arms are for 30 years.
The Index will be the 1.25% and the Margin will be the 2.75% what you do
is add them together to get your qualifying rate of 4%.
Payment Shock may occur if your mortgage payment rises very sharply at the first adjustment.
Let's see what would happen in the second year if the rate on your discounted 4% ARM were to rise to the 6% "standard" rate on a $100,000.00 Mortgage.
You would start off paying $477.42 dollars per month (not including taxes and insurance) to $599.55, that is $122.13 jump in your monthly mortgage payment.
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You can see what might happen if you choose an ARM because of a low initial rate. You can protect yourself from large increases by looking for a mortgage with features, described next, that may reduce this risk. ARM Interest Rate Monthly Payment 1st year (w/discount) @ 8% $476.95 2nd year @ 10 % $568.82 ARM Interest Rate Monthly Payment 1st year (w/discount) @ 8% $476.95 2nd year @ 12% $665.43 |
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HOW
CAN I REDUCE MY RISK:
Besides offering an overall rate ceiling, most Arms also have "caps"
that protect borrowers from extreme increases in monthly payments. Others
allow borrowers to convert an ARM to a fixed-rate mortgage.
While they may offer real benefits in decreasing your current monthly mortgage payment, these Arms may cost more later down the road. Many of these lenders do not provide you with these low interest loans (below bank rate) unless you have adequate equity in your home to support any negative amortization that may increase.
WHAT IS NEGATIVE AMORTIZATION:
Negative Amortization also known as (deferred interest) is simply paying less than the principal and interest due. When you look at a Fixed Rate loan is it allotted to make up for any difference that a lender may suffer. Fixed Rates are typically higher for the simple reason of yield in the long-run.
INTEREST CAPS COME IN TWO VERSIONS:
Periodic caps: which limit the interest-rate increase from one adjustment period to the next; and * Overall caps, which limit the interest-rate increase over the life of the loan.
Interest-Rate Caps: an interest-rate cap places a limit on the amount your interest rate can increase, these caps are important because your payment will never increase more than the cap allowed.
PRE-PAYMENT PENALTY:
Some agreements may require you to pay special fees or penalties
if you pay off the ARM early. Many Arms allow you to pay the loan in full
or in part without penalty whenever the rate is adjusted.
Prepayment details are sometimes negotiable. If so, you may want to negotiate for no penalty, or for as low a penalty as possible.
Conversion:
Your agreement with the lender may include a clause that lets you convert
the ARM to a fixed-rate mortgage at designated times. When you convert,
the new rate is generally set at the current market rate for fixed-rate
mortgages.
The interest rate or up-front fees may be somewhat higher for a convertible ARM. Also, a convertible ARM may require a special fee at the time of conversion.
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