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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