ARM is an acronym for Adjustable Rate Mortgage, and there are many different varieties of them available through most mortgage lenders.
ARMs can be very appealing finance vehicles for a home purchase or refinance, but it's very important when shopping for an adjustable rate mortgage that you fully understand how it works.
Part of the mortgage problem that has recently plagued the economy was a result of ARMs adjusting to rates and payments the borrowers could no longer afford, thus resulting in default.
Many of these horror stories may never have happened if the borrowers had been better informed on exactly what they were getting.
The name really says a lot about these loans; they are mortgages with rates that adjust.
While there are many different types of adjustable rate mortgages, there are certain basic components that are key to all of them.
These include the initial interest rate, or teaser rate as it is sometimes called, the index, the margin, the caps and the adjustment periods.
The initial interest rate is just that.
It is the rate of interest that the mortgage payment will be based on during the first adjustment period.
These rates are often set lower than fixed rates in order to entice borrowers to choose them, hence the term "teaser rate.
" Sometimes this rate can be significantly lower than prevailing fixed rates, and it makes this mortgage product hard to resist.
This is especially true when you consider that the borrower will be qualified at this deeply discounted rate, thus making far more people eligible for this type of loan than the higher fixed rate mortgage.
There is an inherent danger in this method of qualification however.
Once that first adjustment period is up, the rate will almost always adjust upward by as much as 5% or higher, and the borrower that once qualified for the deep discount rate now has a hard time making the payments once they've been adjusted up to the new interest rate.
A prudent lender will qualify a customer at the anticipated rate at the first adjustment, thus making sure the payment hike will not be financially fatal to the borrower.
A prudent mortgage shopper will also consider their ability to make payments after one or two adjustments of the interest rate.
Running the numbers on a worse case scenario, figuring the maximum payment adjustments and a realistic adjustment to income projected over the next one or two years is a sure defense against being lured into the wrong mortgage product just by its pretty interest rate.
The index and the margin are factored in unison.
The index is the market driven component to which the margin is added to calculate what is known as the fully indexed rate, and provided it is not inhibited by the caps, it will be the borrower's interest rate for the next adjustment period.
The index is usually something very indicative of the market, and to avoid rate adjustments being calculated on a blip in the market, a 52 week average of the indicator is usually used.
One such index is the 52 week average of the 1 year Treasury posted by the Wall Street Journal.
This is a common index for one year ARMs.
At the predetermined adjustment date, the margin will be added to the index (then usually rounded to the nearest .
125%) to determine the new interest rate.
The only thing that could prevent this from becoming the prevailing rate would be the adjustment caps.
The caps are limitations specified in the mortgage Note as to how far the interest rate can adjust in any given period of time.
There are usually two caps involved: the first is the per adjustment cap, the second being the lifetime cap.
In order for the fully indexed rate as calculated as described earlier to become the new interest rate, it must fall within the limits of the per adjustment cap.
Otherwise the newly adjusted interest rate will be cut back to the capped rate, which is the previous interest rate plus the per adjustment cap.
In other words, the final adjusted rate will be the lesser of the fully indexed rate or the capped rate.
The lifetime cap is a rate spread applied to the initial interest rate to determine the absolute maximum increase in the interest rate over the life of the loan.
No matter what the market does or how high the index figures go, the adjusted interest rate can never exceed the sum of the initial interest rate plus the lifetime cap.
To peruse the different types of ARM financing available, visit www.
homemortgage4u.
homestead.
com [http://www.
homemortgage4u.
homestead.
com/].
There you will find a wide range of mortgage options to explore, and where the details aren't already spelled out clearly, ask for them.
Knowing the adjustment mechanism of an ARM is key to determining which one is right for any borrower.
Qualifying themselves at the first or second capped rates would be a wise move to make sure that their income will be sufficient not only to qualify for the initial rate, but also to absorb the payment increases one or two years out.
Knowing the index the ARMs are tied to and the margin the lender will apply will enable them to project those increased interest rates.
When you crunch the numbers the right way, your ARM won't come back to slap you in the face later.
ARMs can be very appealing finance vehicles for a home purchase or refinance, but it's very important when shopping for an adjustable rate mortgage that you fully understand how it works.
Part of the mortgage problem that has recently plagued the economy was a result of ARMs adjusting to rates and payments the borrowers could no longer afford, thus resulting in default.
Many of these horror stories may never have happened if the borrowers had been better informed on exactly what they were getting.
The name really says a lot about these loans; they are mortgages with rates that adjust.
While there are many different types of adjustable rate mortgages, there are certain basic components that are key to all of them.
These include the initial interest rate, or teaser rate as it is sometimes called, the index, the margin, the caps and the adjustment periods.
The initial interest rate is just that.
It is the rate of interest that the mortgage payment will be based on during the first adjustment period.
These rates are often set lower than fixed rates in order to entice borrowers to choose them, hence the term "teaser rate.
" Sometimes this rate can be significantly lower than prevailing fixed rates, and it makes this mortgage product hard to resist.
This is especially true when you consider that the borrower will be qualified at this deeply discounted rate, thus making far more people eligible for this type of loan than the higher fixed rate mortgage.
There is an inherent danger in this method of qualification however.
Once that first adjustment period is up, the rate will almost always adjust upward by as much as 5% or higher, and the borrower that once qualified for the deep discount rate now has a hard time making the payments once they've been adjusted up to the new interest rate.
A prudent lender will qualify a customer at the anticipated rate at the first adjustment, thus making sure the payment hike will not be financially fatal to the borrower.
A prudent mortgage shopper will also consider their ability to make payments after one or two adjustments of the interest rate.
Running the numbers on a worse case scenario, figuring the maximum payment adjustments and a realistic adjustment to income projected over the next one or two years is a sure defense against being lured into the wrong mortgage product just by its pretty interest rate.
The index and the margin are factored in unison.
The index is the market driven component to which the margin is added to calculate what is known as the fully indexed rate, and provided it is not inhibited by the caps, it will be the borrower's interest rate for the next adjustment period.
The index is usually something very indicative of the market, and to avoid rate adjustments being calculated on a blip in the market, a 52 week average of the indicator is usually used.
One such index is the 52 week average of the 1 year Treasury posted by the Wall Street Journal.
This is a common index for one year ARMs.
At the predetermined adjustment date, the margin will be added to the index (then usually rounded to the nearest .
125%) to determine the new interest rate.
The only thing that could prevent this from becoming the prevailing rate would be the adjustment caps.
The caps are limitations specified in the mortgage Note as to how far the interest rate can adjust in any given period of time.
There are usually two caps involved: the first is the per adjustment cap, the second being the lifetime cap.
In order for the fully indexed rate as calculated as described earlier to become the new interest rate, it must fall within the limits of the per adjustment cap.
Otherwise the newly adjusted interest rate will be cut back to the capped rate, which is the previous interest rate plus the per adjustment cap.
In other words, the final adjusted rate will be the lesser of the fully indexed rate or the capped rate.
The lifetime cap is a rate spread applied to the initial interest rate to determine the absolute maximum increase in the interest rate over the life of the loan.
No matter what the market does or how high the index figures go, the adjusted interest rate can never exceed the sum of the initial interest rate plus the lifetime cap.
To peruse the different types of ARM financing available, visit www.
homemortgage4u.
homestead.
com [http://www.
homemortgage4u.
homestead.
com/].
There you will find a wide range of mortgage options to explore, and where the details aren't already spelled out clearly, ask for them.
Knowing the adjustment mechanism of an ARM is key to determining which one is right for any borrower.
Qualifying themselves at the first or second capped rates would be a wise move to make sure that their income will be sufficient not only to qualify for the initial rate, but also to absorb the payment increases one or two years out.
Knowing the index the ARMs are tied to and the margin the lender will apply will enable them to project those increased interest rates.
When you crunch the numbers the right way, your ARM won't come back to slap you in the face later.