ARM Mortgages

Author: Ryann Cairns
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One of the most frequently asked questions among both first time home buyers and those moving up to a bigger home is whether to take out a traditional fixed rate mortgage or go with a variable rate mortgage instead. While this can be a complicated question and the answer will generally be determined by the direction of interest rates, this article will try to answer that time honoured question and give you some background on your adjustable rate mortgage (ARM) options.

Typical fixed rate mortgages charge a fixed interest rate throughout the life of the mortgage, generally for either 15 or 30 years. An adjustable rate mortgage, on the other hand, features interest rates that fluctuate with the general direction of interest rates. When interest rates change, the home buyer’s monthly mortgage payment changes along with it. When should home buyers consider an adjustable rate mortgage?

An adjustable rate mortgage makes sense if the home buyer believes that interest rates will either remain stable or decline over the life of the mortgage loan. If interest rates move downward, so will your monthly mortgage payments. In addition, an adjustable rate mortgage can be an attractive option for short-term mortgages. If you will not be in your home more than a few years, an adjustable rate mortgage may be a good option for you. An adjustable rate mortgage allows home buyers to take advantage of the initial lower interest rate and use the appreciation in home prices to potentially save a lot of money.

What are the main components of an adjustable rate mortgage? The three major components to any adjustable rate mortgage are:

  1. The ongoing “prime minus” feature of the ARM – this is the rate the home buyer is charged on an ongoing basis. It is based on the bank’s prime rate minus some number that is determined at the time the mortgage loan is written. The interest rate charged on the adjustable rate mortgage will fluctuate along with the underlying interest rate.
  2. The “teaser” rate – this is the interest rate charged for the first three to nine months of the adjustable rate mortgage. This is the interest rate the bank advertises to generate interest in their adjustable rate mortgage loans. A good rule of thumb that home buyers can follow is that if the teaser rate is too good to be true, the adjustable rate mortgage may have some unattractive terms. The bank may advertise the low teaser rate in hopes of sucking you in and sticking you with a bad mortgage loan down the road.
  3. The lock-in feature – this is the interest rate which you can lock-in some time down the road. If you decide you would rather have a fixed rate mortgage than an adjustable rate mortgage, you can use this lock-in feature to lock-in a specified interest rate at some time in the future.

Watch out for this feature, as many lenders will not fully disclose the interest rate of the lock-in until you already have the mortgage loan. An adjustable rate mortgage is not for every borrower. But for certain homeowners it can be the right move.

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