Choosing an ARM is a good idea when:
ARMs have the following distinguishing features:
IndexAn adjustable rate mortgage's interest rate increases and decreases based on publicly published indexes. ARMS are based on different indexes including:
MarginMargin is a fixed percentage amount that is pointed added to the index – accounting for the profit the lender makes on the loan. Margins are fixed for the term of the loan.
Adjustment FrequencyAdjustment frequency reflects how often the interest rate changes – also known as the reset date. Most ARMs adjust yearly, but some ARMs adjust as often as once a month or as infrequently as every five years.
Initial Interest RateThe initial interest rate is the interest rate paid until the first reset date. The initial interest rate determines your initial monthly payment, which the lender may use to qualify you for a loan. Often the initial interest rate is less than the sum of the current index plus margin so your interest rate and monthly payment will probably go up on the first reset date.
Interest Rate CapsInterest rate caps put limits on interest rates and monthly payments.
Initial Adjustment CapAn initial adjustment cap limits how much the interest rate can change at the first adjustment period.
Periodic Adjustment CapA periodic adjustment cap limits how much your interest rate can change from one adjustment period to the next. Usually a six-month adjustable rate mortgage will have a one percent periodic adjustment cap while a one-year adjustable rate mortgage will have a two percent periodic adjustment cap.
Lifetime CapA lifetime cap sets the maximum and minimum interest rate that you may be charged for the life of the loan. Most ARMs have caps of 5% or 6% above the initial interest rate.
Negatively Amortizing LoansBecause Negatively Amortizing Loans provide payments caps instead of interest rate caps, they limit the amount the monthly payment can increase. However, there is a risk interest rates could potentially escalate to a point where the monthly payment would not cover the interest being charged. If this scenario were to occur, the extra interest charges would be added to the principle of the loan, resulting in the borrower owing more than was initially borrowed. Borrowers are usually allowed to make payments over the loan amount to pay down the mortgage and guard against this scenario.
Option ARM loansOption ARM loans allow the borrower to choose the amount to pay toward the mortgage each month. Make a minimum payment, interest-only payment, 30-year amortized payment or 15-year amortized payment. Pay the minimum amount to free up funds for other uses, or make larger payments for faster equity build up. Option Arms offer much more cash flow flexibility but must be used wisely by the borrower. Always consult a qualified loan officer to learn about all of the risks associated with these types of loans. He or she will also be able to offer valuable advice on properly managing your monthly payments.