What Are Adjustable Rate Mortgages?
Adjustable rate mortgages, also known as ARM, is different than traditional fixed rate mortgage loan programs because the intial mortgage rates are not fixed for 15 or 30 years and fluctuate based on the index after the initial fixed rate period. Adjustable rate mortgages have an initial fixed rate period, such as 1 year, 3 years, 5 years, 7 years, or 10 years. Adjustable rate mortgages are amortized for 30 years, however, the rates change annually after the initial fixed rate period. Adjustable rate mortgages have lower starter mortgage rates than 30 year fixed rate mortgages. The reason for adjustable rate mortgages having lower starter rates initially is because the mortgage lender is not bound for 30 years on the initial rate given the mortgage loan borrower. The mortgage lender is only liable to honor the fixed rate for either 1 year, 3 years, 5 years, 7 years, or 10 years and the lender can readjust the mortgage rates depending on what the market index rate is at that time. After the initial fixed rate period, adjustable rate mortgages adjust every year thereafter for the remaining 30 years. The adjustment is based on the index and the margin. The index varies from year to year but the margin is the same. The new rate after the fixed rate period expires is the index plus the margin which will yield the new annual rate.
Indexes: Adjustable Rates Mortgages Are Tied To One Of Three Major Indexes
1. Cost Maturity Treasuries: CMT
Cost Maturity Treasuries are the one year treasuries and probably is the most conservative index out of the three indexes.
2. COFI: Cost of Funds Index
Cost of Funds Index is the interest rate that financial institutions currently paying on the deposits they hold in the western district of the United States.
3. LIBOR: London Interbank Offered Rate
The London Interbank Offered Rate is the rate where international lending institutions are charging one another on loans.
Adjustable Rate Mortgages: Caps On ARMs
Caps are implemented on adjustable rate mortgages for the protection of the borrower in the event the index sky rockets where the borrower can no longer afford the monthly payment. The purpose for caps on adjustable rate mortgages is to limit the amount the adjustable rate mortgages interest rates where it limits the mortgage payments.
Advantages Of Adjustable Rate Mortgages Over Fixed Rate Mortgages
Adjustable rate mortgages have lower starter interest rates. Adjustable rate mortgages are ideal for home buyers who do not plan on living on their new home for more than 7 years. If you are a first time home buyer and are purchasing a starter home and plan to move within the next 5 to 10 years, adjustable rate mortgages may be your better option because mortgage rates are substantially lower than 30 year fixed rates mortgage loans.