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.

There are various types of caps for adjustable rate mortgages.  The most popular and common caps is the Periodic Caps which limits the amount of the rate can change at any one time.  They are normally annual caps that will forbid a mortgage rate from going up a certain percentage in any given year.  Another type of caps is the lifetime cap where it limits how much the mortgage rate can be over the lifespan of the mortgage loan.  Another form of caps is a payment cap where it limits the maximum monthly payment can rise over the lifespan of the mortgage loan in dollars rather than rates.

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.

The information contained on Gustan Cho Associates website is for informational purposes only and is not an advertisement for products offered by The Gustan Cho Team @ Gustan Cho Associates or its affiliates. The views and opinions expressed herein are those of the author and/or guest writers of Gustan Cho Associates Mortgage & Real Estate Information Resource Center website and do not reflect the policy of Gustan Cho Associates Lenders Network, its officers, subsidiaries, parent, or affiliates.

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