Interest-only mortgage loans are a source of confusion for many homeowners. If you need the lowest possible payment while minimizing your risk of payment shock, an interest-only mortgage could be your answer. Here are the basics you need to understand about interest-only Adjustable Rate Mortgages (ARM) to make an informed decision and minimize your risk when refinancing.
Adjustable Rate Mortgages 101
What are Adjustable Rate Mortgages and how do they differ from a conventional fixed interest rate loans? Adjustable Rate Mortgages are simply mortgage loans that have a variable interest rate that changes over time. How often your mortgage rate changes depends on the lender and the type of Adjustable Rate Mortgage you’ve chosen; however, every 24 months is a common adjustment period.
What happens when your lender adjusts your mortgage rate? When your mortgage lender adjusts the interest rate they will change your rate to whatever index your loan is tied to plus the lender’s margin. The margin your lender adds is their markup to cover expenses and profit on your loan. When shopping for an Adjustable Rate Mortgage the lender’s margin is an important consideration to make when choosing a loan offer.
What is an index? The index determines your base mortgage rate. Key financial indexes commonly used by mortgage lenders include the Prime Rate, the LIBOR (London InterBank Offered Rate…lenders like this one because they can sell loans tied to the LIBOR to European investors), and the Treasury Index. These interest rates rise and fall based on the supply and demand of credit and other economic factors.
Adjustable Rate Mortgage Features
If you are in the market for an Adjustable Rate Mortgage there are three loan features you need to look at in the offers you consider. These features are the index, margin, and caps. We’ve already discussed index and margin; caps are safety features used to minimize your risk of payment shock when refinancing with an Adjustable Rate Mortgage.
What is payment shock? Imagine waking up one day to a statement from your lender showing that your mortgage rate has gone from 7.5% to 10.5% and your new payment amount will be $700 higher. Fortunately, Adjustable Rate Mortgage loans have built in safety features to protect your from a nightmare like this.
Caps are Adjustable Rate Mortgage safety features that can protect you from payment shock when structured correctly. There are two varieties of caps and you need to make sure your Adjustable Rate Mortgage comes with both types. The first type of cap is called a periodic, or interest rate cap. This cap limits how much your lender can adjust your interest rate up or down during an adjustment period. The second type is payment cap that limits how much your lender can raise or lower your monthly payment during an adjustment period. Both types of caps an have a lifetime cap meaning that the total changes, up or down, are limited over the duration of your loan.
