What is an Adjustable Rate Mortgage?
One type of mortgage that is becoming increasingly common is the adjustable rate mortgage or ARM. In this type of loan, the interest rate will change over the life of the loan, generally in six-month increments and in response to one of the loan rate indexes used by the real estate lending industry.
Adjustable rate mortgages are often available to borrowers who cannot qualify for a fixed-rate mortgage, particularly if they do not have a sufficient down payment saved or if their income is right on the boundary of being able to qualify. Because the lender is not locked into a particular interest rate for the life of the loan, they can offer an ARM to borrowers who would be considered too risky for a fixed-rate mortgage.
However, the fact that the interest rate on an ARM can change should not make you afraid that you will suddenly be experiencing enormous jumps in the interest rate. There are limits on how much the interest rate can change each time it resets. These limits are known as caps, and help protect the borrower from extreme volatility in the credit market.
For instance, a lender might offer an adjustable rate mortgage with a one percent cap for any six month time period and a four percent total cap for the entire loan. If you were to sign on a loan under these terms and started with a 6% interest rate, it would not be able to go up to more than 7% the first time it adjusted, and even if interest rates went up for the next five years running, your interest rate would never go higher than 10%, no matter how high interest rates go in the real estate industry.
On the other hand, if interest rates should suddenly decline sharply, these caps also limit how fast and how far the interest rate you are paying can go down. If you want to take advantage of a major drop in interest rates, you would need to refinance, which would involve additional closing fees that could negate the savings of getting a better interest rate. However, if you could qualify for a fixed-rate loan as a result of having built equity in your home, you would be able to lock in a low rate and protect yourself against future interest rate jumps.
Because interest rates vary by location, you will want to make sure to do your homework and research rates in your housing market before you sign an adjustable rate mortgage. You may want to look into retaining the services of a mortgage broker to help you determine what is the best deal that is most appropriate to your financial circumstances.
When you have an ARM, you will want to keep an eye on mortgage rates. Although your mortgage company will notify you when the rate actually adjusts, it is best to know what interest rates are doing so you don't get caught by surprise and throw your family budget out of kilter. The financial section of your local newspaper will usually have information on interest rates, as will a number of good financial websites.
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