Understanding an Adjustable Rate Mortgage
Adjustable rate mortgages are housing loan options that allow the lender to transfer some of the risk associated with the loan to the borrower. The interest rate on an adjustable rate mortgage is dependent upon the index, or the cost the lender faces in the credit market. It is one of many different mortgage options, and is a common option within the United States.
There are nine main aspects of an adjustable rate mortgage that those considering the option should know and understand. The first is the initial interest rate. This is the interest rate given to the borrower at the beginning of the loan. It is typically lower than those give for fixed rate mortgages because it does have the option of rising in a tough market. This period is fixed for the intial period. IE: 5 year arm the payment is fixed for 60 months. This is the period during which the interest rate will not change. Upon reaching the conclusion of this period, the interest rate may change based on the index, and the monthly payment will subsequently change as well.
Third is the index rate. This is the factor that will affect the interest rate for the adjustable rate mortgage. The index is often based on either Treasury securities or the cost of funds to savings and loan associations. Then there is the adjustment period. The adjustment period is based upon index + margin = interest rate. The index is tied to either LIBOR, MTA, COFI and TBill indexes. This can change monthly or annually depending on the terms agreed upon with your lender.
Fourth is the margin, or the amount of percentage points added to the index rate to determine the interest rates. Margin is fixed for the life of the loan and is considered the banks overall profit.
There are also interest rate caps, or the amount that the interest rate can be changed from period to period over the lifetime of the loan.
The sixth important aspect is the initial discounts, which is when the lender will agree to lower the interest rate below the actual rate of index plus margin as a promotion for a period of time.
Borrowers should also understand negative amortization. When this happens, the mortgage balance actually increases because the maximum monthly payment is less than the actual interest plus principal. The negative amortization loan products have been discontinued due to the housing crisis.
The eighth important aspect is the conversion, when the lender allows the borrower to change from an adjustable rate mortgage to a fixed rate mortgage at particular periods. This option will need to be in your intital mortgage paperwork.
Finally, there are prepayment considerations for an adjustable rate mortgage. Sometimes lenders will include language that will penalize borrowers if they pay off the mortgage early. A majority of lenders are not asking for pre-payment penalties in todays mortgage market.
Understanding these important aspects of adjustable rate mortgages can help those considering the option make a wise choice. The benefit of having a lower starting interest rate is alluring, although there is also risk involved. It is always best to speak with a financial professional when considering an adjustable rate mortgage. Core Mortgage Financial are experts in adjustable rate mortgages. Call us today for a no obligation loan analysis.
This blog is for informational purposes only. Please consult your attorney for all Florida Law questions. NMLS #849597