Adjustable Rate Mortgages Versus Fixed Rate And Its Benefits

This Article Is About Adjustable Rate Mortgages Versus Fixed Rate And Its Benefits

There are times where borrowers will benefit from ARMs versus Fixed Rate Mortgages.

  • Interest Rates are much lower with Adjustable Rate over Fixed Rate Loans
  • Monthly Principal and Interest Payments may not be the same with Adjustable Rate Mortgages Versus Fixed Rate for the entire 30-year term

Benefits Of ARMs Over Fixed-Rate Mortgages

What are the benefits of an ARM over a fixed rate mortgage

Here are times where homebuyers may want to go with Adjustable Rate over Fixed Rate Mortgages:

  • First Time Home Buyers purchasing a starter home
  • Mortgage Borrowers who plan on moving in five to ten years
  • Home Buyers planning on refinancing after a few years

In this blog, we will detail the differences and benefits of adjustable-rate over fixed-rate mortgages.

Difference Between ARM Versus Fixed Rate

Adjustable-rate mortgages, also known as ARM, are different than traditional fixed-rate mortgage loan programs. The initial mortgage rates are not fixed for 15 or 30 years. ARM is fixed for an initial period then fluctuates every year based on the index after the initial fixed-rate period.

Adjustable-rate mortgages have an initial fixed-rate period, such as the following:

  • 3 years
  • 5 years
  • 7 years
  • 10 years

Amortization On ARMs

What are Indexes: Adjustable rates Mortgages are linked to one of three main indexes

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
  • Lenders are only liable to honor the fixed rate for the fixed-rate period 3 years, 5 years, 7 years, or 10 years
  • 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: ARMs Are Tied To One Of Three Major Indexes

Cost Maturity Treasuries: CMT:

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

LIBOR:  London Interbank Offered Rate:

Adjustable Rate Mortgages: Caps On ARMs

What are the advantages of variable rate mortgages over fixed rate mortgages

Caps are implemented on adjustable-rate mortgages for the protection of the borrower in the event the index skyrockets 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 that 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 that can rise over the lifespan of the mortgage loan in dollars rather than rates.

Advantages Of Adjustable Rate Over Fixed-Rate Mortgages

Adjustable-rate mortgages have lower starter interest rates.

  • Adjustable-rate mortgages are ideal for homebuyers who do not plan on living in their new home for more than 7 years
  • First Time Home Buyers who are purchasing a starter home and plan to move within the next 5 to 10 years, adjustable-rate mortgages may be the better option because mortgage rates are substantially lower than 30 year fixed rate loans

Gustan Cho Associates is a national mortgage company with no overlays on government and conventional loans. Home Buyers who need to qualify for a mortgage with a direct lender can contact us at Gustan Cho Associates at 262-716-8151 or text us for a faster response. Or email us at [email protected]

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