When it comes to home loans, there are several types available. Two popular categories of mortgages are the adjustable rate mortgage (ARM) and the fixed rate mortgage. Both types have their own set of sub-types (hybrid ARMs, 15 year fixed rate mortgages, etc.) and all have their own set of benefits and drawbacks.
When comparing ARM rates to fixed mortgage rates, you will typically see a lower initial rate on the ARM. This makes them an attractive choice for many borrowers. However, ARM rates don't always stay low. Sometimes homeowners who were lured in by a drastically low rate upfront find it hard to make their monthly payments after the rate has jumped.
Before signing up for an ARM, ask your lender about details regarding possible conversion to a fixed rate loan in the future. According to Fannie Mae's website, many ARMs offer borrowers the option to convert to a fixed rate loan at specified times during the early years of the mortgage. The conversion availability times can either occur periodically (which allows the borrowers the option of converting on specified interest rate change dates) or monthly (which allows the borrowers to convert at the beginning of every month for a specified period of time).
There are a few eligibility requirements for conversion and not every ARM loan will carry the same conversion times, so it's best to speak directly with your lender for more information.
As you probably know, the "ARM" in ARM loan stands for adjustable rate mortgage. This means that your interest rate is subject to change, at least once a year. Most ARM loans will have an introductory fixed rate period at first (normally 3, 5, 7, or 10 years) but will then be adjusted, either up or down, at a set interval for the remainder of the loan.
So, how does your lender determine your adjusted rate? In order to answer this question, you need to understand a little bit about the structure of an ARM loan.
ARM loans have four primary components: index, margin, rate caps and initial rate period. We've already mentioned the initial rate period (where the rate remains set for the first few years of the loan), but when that period is up, your lender will adjust your rate by adding the margin to the index at that time.
The margin is a fixed number that will be disclosed to you at the time of loan application and again at closing. Margins vary from lender to lender, so it's a good idea to shop around for a low margin. The index is a fluctuating number that moves up or down. As it does so, your interest rate will be adjusted accordingly. The a multiple indexes used by mortgage companies.
The rate cap structure protects the borrower from drastic upswings in interest rates. Your rate cap will vary, depending on the type of ARM loan you have.
Adjustable rate mortgages can be a smart option for some buyers, but they won't be the best choice for everyone. It's a good idea to weigh all the options before committing to a particular loan program.
Related Posts and Resources:
Reasons to Consider an Adjustable Rate Mortgage
Freddie Mac's HomeSteps Program
What is Condotel Financing?
