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Get to Know the Adjustable Rate Mortgage

Tuesday, April 22, 2014 - Article by: Lender411 Member

The Adjustable Rate Mortgage, ARM, is a good alternative for borrowers who are comfortable with risk, or borrowers whose income fluctuates through the year. The risk that a borrower takes when he/she acquires an ARM, is the potential for interest rates to go up; but just as likely, the borrower may be rewarded with interest rates going down

Relative to the fixed rate loan products, this type of loan requires smaller monthly payments upfront, and therefore, is attractive to first time home buyers who have small incomes but want to own a home. the monthly payment of this type of loan may increase or decrease depending on the interest rate index to which the loan terms are tied to.Generally, a adjustable rate mortgage is characterized by the following:

  • an initial rate (also known as the intro rate, or teaser rate) which will be adjusted at some time in the near future. The adjustment will dictated by the interest rate index to which the loan is tied to, and also by the loan caps
  • caps limit the potential upward/downward change of the loans interest rates whenever an adjustment period comes up. All loans have two types of caps, periodic and overall loan caps.
    • periodic caps limit the rate increase/decrease from adjustment period to adjustment period
    • overall loan caps limit the maximum rate increase/decrease for the life of the loan
    • example: For example an ARM with caps 4/1.5/4 means the interest rate may change +/- 4% when the first adjustment hits, all subsequent rate adjustments may be =/- 1.5%, and during the life of the loan, the rate adjustment may not exceed 4%

Common variations of Adjustable Rate Mortgages are:

  • One year ARMs
    • adjustment to initial interest rate happens a year after the purchase of the loan
    • usually, this type of loan has the lowest interest rates in the market
  • Hybrid ARMs
    • these loans are a combination of fixed and adjustable interest rates through the life of the loan
    • these type may have two phases, the fixed period and the adjustable period. For example, a 5/1 ARM is characterized by a five year fixed rate, and rate adjustment every year thereafter. A 10/1 ARM is characterized by a 10 year fixed rate period, followed by an adjustable rate every year thereafter
  • Option ARMs
    • the loans of this type of loan give the borrower the option on how their payment will be handled every given month. For example, any given month, a borrower may choose to apply his/her payment according to a 15-year fixed loan. The portion of the payment that will towards interests will depend on the borrowers equity
    • in cases where a lien holder wants to help a troubled borrower keep his/her home, the lender may offer to modify the loan to a variation of this type. Then, the borrowers payments may be reduced, most likely as low as possible so that only interest charges are covered, while his/her financial situation gets better

ARMs interest rates are tied to commonly used Interest Rate Index. Some of these are:

Adjustable rate loan products can be a good alternative for borrower who can handle the pressure of potential interest rate increases. The best candidates for these products, are borrowers with a good credit history who can refinance an ARM quickly if the economic data turned against their bet for stable or lower interest rate movements.

Good ways to manage and ARM, is to know and be alert to end of the introductory rate, and first adjustment changes. Another good piece of information, is to know prepayment limitations, if any.

ARMs give potential homeowners an opportunity to finance their dream home. However, there are risks attached to this type of product, and potential borrowers must make every effort to understand these risks, and be prepared for the best and worst case scenario.

Nations Lending Corporation differentiates itself through its common sense underwriting. We make it our mission to carefully look at every loan application. Our mortgage branch opportunities feature average 28-day closings with minimum overlays. As a mortgage banker with direct agency, we do not offer a net branch, but we are a far better alternative than any mortgage net branch opportunities out there. Please, visit our website to learn more.

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