Homeowners looking for creative financing may be wondering just what is an adjustable rate mortgage. An adjustable rate mortgage, often known simply as an ARM, is a special type of mortgage loan. Adjustable rate mortgages can often allow you to purchase a house with lower mortgage payments for the first several years of the loan.
However, adjustable rate mortgages can be a dangerous endeavor. In fact, the United States mortgage crisis of 2007 and 2008 was caused, in part, by problematic adjustable rate mortgages. Due to the risks, it is essential for those interested in an adjustable rate mortgage to find out exactly what is an adjustable rate mortgage and when it is appropriate to take this type of loan.
What is an Adjustable Rate Mortgage?
Conventional mortgages, or conventional loans, are known as fixed rate mortgages. When you buy a home using a fixed rate mortgage, your interest rate is set for the duration of the loan- usually fifteen or thirty years. Under a fixed rate mortgage, you pay the same mortgage payment every month for the entire term and there are no changes unless you refinance or pay early.
Adjustable rate mortgages are considered a type of alternative financing. Under an adjustable rate mortgage, your interest rate is not set for the life of the loan. Instead, the interest rate adjusts based on current market interest rates. Usually, the interest rate of the mortgage is tied to the LIBOR index, the Cost of Funds Index, the Treasury Securities Index, or to the lender's cost of funds.
The terms of your adjustable rate mortgage will specify how frequently your rate adjusts. Rates can adjust every six months, every year or every several years. Some loan contracts will also specify just how many percentage points the mortgage can adjust within a given period of time. You may also be able to request that a cap be included in the contract to stipulate that the interest rate cannot go above a certain level regardless of the prevailing interest rates.
Often, a low interest rate is offered for the first several years of an adjustable rate mortgage as an incentive to get borrowers to take this type of loan. This promotional rate is a fixed interest rate and can last anywhere from six months to several years before your interest rate adjusts upwards to prevailing market rates, or higher. If you take this type of loan, it may be referred to as a hybrid ARM because the low interest rate is fixed during the promotional period.
Who Should Take an Adjustable Rate Mortgage
ARMs aren't for everybody. This type of financing may be best for young families with burgeoning income potential. Since the rates for these mortgages are usually lower during the first few years, borrowers can afford to buy a home sooner with the idea that their income will increase by the time their payments increase. However, there is a risk associated with this course of action, since if your income does not increase and/or mortgage rates become too high, you may find yourself unable to make your house payments.
Experts used to suggest that it also might be wise for a person who is planning to refinance or move within two to five years to take an ARM in order to take advantage of the low interest rates for the time period they intend to live in the home. However, the 2008 and 2009 mortgage crisis demonstrated that if your property falls in value, you may be unable to sell your home for the amount you owe on the mortgage and/or be unable to refinance. When this occurs, you could find yourself unable to sell or refinance, and facing mortgage payments that jump to more than you could reasonably afford to pay in a month.
If you intend to take an adjustable rate mortgage, ensure that you have cash reserves or wiggle room in your budget to accommodate higher-than-expected mortgage payments. You would also be wise to put down a down payment on your home and ensure you have good credit so that you can refinance or sell should your property values fall or your adjustable rate become too high. Finally, before you take this loan, make sure you fully understand the answer to the question of what is an adjustable rate mortgage and that you have read and understood the complete terms of your mortgage loan document.
Original article on Superpages.com
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