Adjustable Rate Mortgages - When They Are the Right Mortgage
Adjustable Rate Mortgages - When They Are the Right Mortgage. Most of us are familiar with tradition rate mortgages. We borrow a fixed amount of money for 15 to 30 y ears and we agree to pay it back at a given interest rate over the life of the loan. Our payments are the same amount every month, whether it is for 5 years or 30 years.
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Adjustable Rate Mortgages - When They Are the Right Mortgage
For the majority of homeowners out there this is the most ideal type of mortgage as it has no surprises or sudden increases in monthly payments. However, for some home buyers, an adjustable rate mortgage may very well be the better financial tool.
An Adjustable Rate Mortgage (ARM) is one that can go up or down over time depending on market conditions. Some ARM's adjust once, while others can adjust several times over the life of the loan.
The main purpose behind an ARM was to let people buy more house then they might be able to afford now assuming that as the years went by their earning power would be greater and thus when the mortgage rate adjusted they could afford the new payment.
Unfortunately, many people don't understand how ARM's work and are often unprepared for when the rate adjustments take place.
There is a segment of the population out there that can benefit from ARM's, regardless of the rates associated with them. Those who plan to be in their home for five years or less typically can save quite a bit by using an ARM vs. a traditional mortgage.
An ARM let's them pay an interest rate that is usually below market rates for the first few years of the loan. Since a homeowner may be planning to move in a short time span (such as when the kids graduate from school) they can take advantage of the low up-front rate and sell the home before the rates have a chance to adjust.
A savvy home buyer who maintains a stellar credit rating could also use ARM's to get a lower rate up front for a few years and then switch to a fixed rate mortgage through a refinance down the road. They may be able to save thousands of dollars in interest by switching from an ARM to a traditional mortgage even after paying the refinance fees.
Finally, ARM's can be the right mortgage for you if you study the markets and know where the rates are heading. If interest rates are currently running high and you know that over time they will settle back down, then getting an ARM can help you take advantage of those lower rates over time while helping protect you from the high rates of today.
Adjustable Rate Mortgages - When They Are the Right Mortgage. Of course, as with any mortgage, you should carefully review with the mortgage lender all of the costs and assumptions. An ARM is not always the best mortgage tool of choice depending on your situation. Make sure you understand what you are signing and always get more than one mortgage rate quote no matter what type of mortgage you go with.
Adjustable Rate Mortgages - This Home Mortgage Loan May Not Be For The Weak At Heart
Adjustable Rate Mortgages - When They Are the Right Mortgage. I heard the news about another interest rate hike and thought it was about time to look into refinancing my mortgage. I contacted my mortgage company first.
"I am interested in a fixed mortgage rate." I said.
"May I ask why that is?" The broker asked politely.
"I don't want to deal with the risk of rising interest rates. At my age, I cannot afford the risk.”
"Looking at your last ten years of history, you have done pretty well with the adjustable rate. In fact, you had paid less in interest than most people with a fixed loan. May I suggest that we look at some adjustable rates, which are even less than the rate you’re paying and with caps you don’t have to worry about the interest rate hikes. I think we can save you a few hundred dollars off your monthly payment."
At this point the broker took a breather so that I can say, "No thank you. I am only interested in a fixed rate mortgages." "I don't understand. Are you not interested in saving money?" He asked before launching into a lecture that had a mix of economy 101, budgeting 1, a dash of fortune telling and a healthy and totally unrealistic optimism of future trend in interest rates.
When he was done I explained to him that I recall the 18%-19% interest on mortgage loans in the early 1980's that he seemed too young to remember. I pointed out that on a $100,000 loan, the 18% interest is $1,500 per month on the mortgage interest alone. If you have a $200,000 loan the interest alone would be a back-breaking payment of $3,000 per month.
I knew he thought I am out of my mind thinking about an 18% mortgage interest rate in today’s environment. At the end we ended the phone conversation without any resolution. The gap in understanding wasn’t about fixed rate mortgages vs adjustable rate mortgages (ARM). The gap was in age, experience, expectation, hopes and fears; a gap too wide to bridge.
To understand this gap, let’s look at the adjustable rate mortgages. This type of mortgage loan is usually lower than the fixed rate and the lower rate means lower payment that in turn means easier qualification.
When lenders are considering your mortgage loan application, they look at what percentage of your income is available for repaying their loan. With an income of $5,000 per month, a $2,000 loan payment is 40% of your income and a $1,000 payment is 20% of your income. The closer you get to $1,000 or 20% of your income, the easier it is to qualify for the loan. This easier qualification appeals to younger people who are just starting and those with income limitation.
Adjustable mortgage rates appeal to young people with an innate optimism, hopes of increased income and the high possibility of moving to a different home in a short period of time. They need to look at what they can afford to pay and cannot worry too much about the distant future. To them anything is better than renting which is absolute waste of money.
There are also those older individuals who have suffered from some set back in life and do not enjoy a high credit score or do not have a very high income. Since a poor credit score increases the interest rate a bank offers to potential borrowers, a fixed rate may be too high for these individuals to consider.
Let’s take a look at some terms that help you understand ARM better.
Margin - This is the lender's markup and where they make their profits. The margin is added to the index rate to determine your total interest rate.
ARM Indexes - These are benchmarks that lenders use to determine how much the mortgage should be adjusted. The more stable the index is the more stable your adjustable loan remains. Consider both the index and the margin when you are shopping around.
Adjustment Period - Refers to the holding period in which your interest rate will not change. You will come across ARM figures like 5-1 that means your mortgage interest remains the same for five years and then it will adjust every year.
Interest Rate Caps - This is the maximum interest a lender can charge you.
Periodic caps - The lenders may limit how much they can increase your loan within an adjustment period. Not all ARMs have periodic rate caps.
Overall caps- Mortgage lenders may also limit how much the interest rate can increase over the life of the loan. Overall caps have been required by law since 1987. Payment Caps - The maximum amount your monthly payment can increase at each adjustment.
Negative Amortization - In most cases a portion of your payment goes toward paying down the principal and reducing your total debt. But when the payment is not enough to even cover the interest due, the unpaid amount is added back to the loan and your total mortgage loan obligation is increased. In short, if this continues you may owe more than you started with.
Negative amortization is the possible downside of the payment cap that keeps monthly payments from covering the cost of interest.
Adjustable Rate Mortgages - When They Are the Right Mortgage. As you compare lenders, loans and rates remember Henry Moore who said, "What's important is finding out what works for you."
Adjustable Rate Mortgages - Talking About Interest Rate Caps
Adjustable Rate Mortgages - When They Are the Right Mortgage. Many people have jumped on adjustable rate mortgages to take advantage of the historically low interest rates we have seen over the last few years. Rates are now rising, which means you need to understand caps.
An adjustable rate mortgage is just what it sounds like. The interest rate can be adjusted to match certain interest rate standards. The advantage of such a loan is it can seriously lower monthly mortgage payments if interest rates are low. Over the last few years, of course, rates have been incredibly low. Rates are now rising and you need to understand what that means for your adjustable rate mortgage.
Since the interest rate on your loan is adjustable, you should be getting a little nervous about rising interest rates. That being said, most loans have graduated step increases and caps that keep things from getting nightmarish too quickly. Here is a closer look.
A good adjustable rate mortgage protects you from massive rate increases through something known as rate caps. There are two types of rate caps. Each has benefits and negatives.
A lifetime rate cap is just what it says. This cap sets the maximum interest rate the lender can charge you for the loan. You must always demand a lifetime cap on any mortgage you take out. Assume you take out an adjustable rate mortgage with an interest rate of four percent. As part of the agreement, the loan has a lifetime cap of eight percent. If interest rates shoot up to 10 percent, your loan will cap out at nine percent. While this is a high interest rate, it is a lot better than paying 10 percent.
Periodic rate caps also protect you, but in a different way. A periodic rate cap defined the maximum percentage your interest rate can increase over a period of time. The shorter the time period, the better the cap. If your loan document allows the lender to adjust the rate every six months, the cap may be as low as one percent. This means the lender can only increase the interest rate by a maximum of one percent, regardless of what the market is charging for new loans.
Adjustable Rate Mortgages - When They Are the Right Mortgage. Adjustable rate mortgages are great when interest rates are low. When rates start creeping up, however, you need to take a close look at your caps.
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