Steadfast FinancesAdjustable Rate Mortgage

Benefits of an Adjustable Rate Mortgage

Filed in Real Estate 4 comments

Adjustable rate mortgages are loans that offer the buyer low interest rates for some set period of time, such as five years. These rates will fluctuate depending on the prevailing market interest rate.

Of course, this means that the interest rates rise or fall depending on the market situation.

This fact is especially important when you are living in a crumbling economy like that of the United States with hardly any national income growth these days.

These are the basic features of adjustable rate mortgages:

  • Initial interest rate- this is the beginning interest rate; usually low.
  • Index rate- this is the base on which the mortgage is based 1-year, 2-year and 5-year treasury securities are common.
  • Adjustment period- this is the length of time that the interest rate on the ARM is set to remain unchanged; normally reset at the end of this period.
  • Interest rate caps- these are limits on how much interest rates or monthly repayments can be changed by the end of the adjustment period or the loan lifetime.
  • Margin- these are percentage points that the lenders add to the index rate given in order to determine the interest rate of the adjustable rate mortgage.
  • Negative amortization- this basically means that the mortgage balance is increasing gradually. This arises when the monthly mortgage payments are not large enough to pay the interest amount due on the mortgage in full at once.
  • Initial discounts- a super-benefit of ARM’s are the initial discounts. These are interest rate concessions normally given in the first year of the ARM or other subsequent years to reduce the overall interest below the prevailing rate.
  • Prepayments- these may arise where the agreement requires the buyer to pay some special fees or a penalty in case the ARM is paid off too early. These terms are negotiable in most cases.
  • Conversion- in some cases, the agreement may allow the buyer to convert the ARM into a fixed rate mortgage. This can be quite essential in times when the prevailing market rate is fluctuating abnormally.

Most people pocket some pretty dollars in the housing boom if they have ARM agreements. This happens because they took the mortgages when the interest rate was low and they can therefore sell these houses when the interest rates are high.

You shouldn’t plan to stay in the same house for the long term if at all you want to enjoy the benefits associated with ARMs.

A great benefit enjoyed with adjustable mortgage rates is the fact that there is no need to refinance the loan in case the interest rates are dropping. The overall payment and monthly interest rates instead drop at the scheduled evaluation rate thus adjusting to the market condition. This is not the same case with fixed rate mortgages where one must refinance the mortgage in order for the rates to drop.

Since adjustable rate mortgages’ interest rates are usually lower than those of fixed exchange rates; owing to the discounts offered, the borrower can comfortably afford the risk of a future increase in the rates. We can, therefore, say that the buyer of an ARM ends up saving some money due to the lower interest rate paid initially.

Recently, an observation of the current crisis in America has laid the blame on ARMs for the housing crisis being faced. However, this is not the case because there are several other thousands of mortgagors who are enjoying great benefits attributed to ARMs. It all depends on the choices that one makes.  If you are looking to buy a house as property investment, this might be a great option. It is also important to be on look out to know when the interest rates have began to rise so that you can sell the house and earn some profit.

Do you have an ARM? Would you purchase a house with an ARM? Why or why not?

YFS is owner and author of Your Finances Simplified. He was born and raised in West Philadelphia and is now a financial adviser, IT contractor, landlord, and treasurer of a non-profit. He created his blog partly due to his desire to help people with their finances.

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Posted by Dominique Brown   @   2 April 2012 4 comments
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4 Comments

Comments
Apr 2, 2012
4:05 pm

You just need to be careful with an ARM – when it adjusts or ends you can get overwhlemed with the increase. Sure, you can simply keep refinancing, but there are costs to that so its not the best long term strategy.

Apr 3, 2012
4:15 pm
#2 Corey :

My brother got a ARM and nearly lost his house when the housing bubble burst. His interest rate went up and he could barely pay his mortgage. His other debt didn’t help the situation, but it certainly is risky.

Apr 3, 2012
7:50 pm
#3 YFS :

ARM’s are good depending on when you get them. When interest rates were high and dropping tremendously home owners with arms benefited when interests rates rise homeowners with arms suffer. It truly depends on how interests rates are going. With that said.. arms are no more risky than fixed rate mortgages

Apr 8, 2012
1:02 pm
#4 YFS :

Well said Kris! Arms just like FRM are a strategy that has benefits and disadvantages. Choose the best strategy for your situation.

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