Adjustable Rate Mortgage
by Vic Bilson
When choosing the right mortgage, it's helpful to know how
mortgage rates work. There are two types of mortgages available in the market.
The first one is a fixed rate mortgage, where the rates are set for the
duration of the loan term. The second one is the adjustable rate mortgage.
In an adjustable rate mortgage, the interest rate periodically changes and
may either increase or decrease, depending on how prime rates are changing.
This fluctuation of the mortgage rate can sometimes lead to customers getting
cheap interest rates, allowing them to save more on their monthly payments. On
the other hand, adjustable rate mortgages may also work against the customer.
Interest rates in adjustable rate mortgages may also increase when prime rates
of lending companies increase.
When it comes to adjustable rate
mortgages, there really are no guarantees. Interest rates will either go down
or it will go up. Lower interest rates mean lower monthly adjustable-rate
mortgage payments. Higher interest rates mean higher monthly adjustable-rate
mortgage payments for you. There is no middle ground. Adjustable rate mortgages
are basically a trade-off – you exchange more risk for a lower rate.
Determining whether or not an adjustable-rate mortgage is the right type
of loan for you usually depends on your financial situation. Adjustable-rate
mortgage payments have characteristics that might ultimately prove risky in the
long run. Because the dynamics of interest rates in the market are never
certain, the amount of your adjustable-rate mortgage payments are uncertain as
well. Since there is little chance of you knowing what your future monthly
payments might be with an adjustable rate mortgage, and because interest rates
may either rise or fall, it is advisable that only those who are financially
secure should get an adjustable rate mortgage.
Because of the
complexities involved, adjustable rate mortgages are usually restricted to
savvy investor types who wish to pay less so that they can channel the extra
funds into other investments. If the low interest rates remain steady,
adjustable rate mortgages could be inexpensive.
When considering
whether an adjustable rate mortgage will be a good investment for you, below
are some questions you need to consider:
- Is there a possibility that my income will rise up
enough to cover higher adjustable-rate mortgage payments should interest rates
go up?
- Is there a chance that I might take on other sizable
debts like a loan for a car or school tuition in the near future?
- Will my adjustable-rate mortgage payments increase even
though interest rates remain the same?
- How long do I plan to own this home? (If you plan on
selling soon, an increase in interest rates should not be a problem.)
How Adjustable Rate Mortgages Work
Adjustable rate mortgages have very low interest rates at the start of its loan
period, sometimes even lower when compared to 15- and 30-year mortgages, thus
making them more affordable and easier on the pocketbook. An adjustable-rate
mortgage may also help you qualify for a larger loan because lenders sometimes
decide to extend a loan based on your current income and that your mortgage
payments can be kept current for the first year. These are some of the main
reasons why homebuyers prefer adjustable rate mortgages.
Loans with an
adjustable-rate mortgage usually have low rates only for a short time, after
which, the monthly payments may increase or decrease. Interest rates of
adjustable rate mortgages are changed on a regular basis based on a
pre-selected index, usually after the first year is over. This means that the
interest rate and the amount of the monthly adjustable-rate mortgage payment
may vary, going either up or down.
There are several kinds of indices
used for adjustable rate mortgages. The most common is the yield on the
one-year Treasury bill. The new interest rate is calculated by adding the index
to a set margin determined by the lender. Inexpensive rates are available in
adjustable rate mortgage programs for one, three, give, seven, and ten years.
The most common adjustable rate mortgage is the 1-year program. This type of
adjustable rate mortgages has a low interest rate for a fixed period of one
year but after which, it is adjusted to suit the index and set margin. Some
types of adjustable-rate mortgages have limits to the interest-rate increase.
When an adjustable-rate mortgage reaches a certain percentage, the interest
rate will no longer increase for the duration of that period. But at the end of
that period, the adjustable-rate mortgage rate can vary once more.
Adjustable rate mortgages may be converted into fixed rates if it becomes
necessary. Adjustable rate mortgages are also assumable mortgages. This means
that an adjustable rate mortgage may be transferred to new buyer who would
assume the same terms of the said mortgage. The new buyer would have to qualify
for the adjustable rate mortgage before he can assume it.
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