Adjustable Rate Mortgages are as the name implies loans that have an interest rate that changes over time. You will often see these loans abbreviated as ARM loans. The interest rate you pay at any given time is based to two factors. The index your loan is tied to changes over time based on any number of factors in the economy. Common indexes are the Treasury Index and the LIBOR Index. There really isn’t any one index better than the others; when shopping for an Adjustable Rate Mortgage you should concern yourself with the lender’s margin over which index you loan based on.
Margin is the amount your lender marks up the index when adjusting your loan. The margin on your loan depends on a number of factors including your credit rating. The more risk you pose to the lender, the higher your margin will be. When comparing Adjustable Rate Mortgage offers pay close attention to the introductory rate, contract rate, and the lender’s margin.
During the introductory period of your Adjustable Rate Mortgage you will have a low fixed interest rate. Many homeowners make the mistake of thinking their payment will remain at this amount; however, at the end of the introductory period the lender will adjust your mortgage to the contract rate and your payment will go up. Introductory periods vary in length; depending on the lender and loan type yours could be anywhere from 6 months to five years.
Risk with an Adjustable Rate Mortgage comes from the chance that your interest rate and payment will go up and you will not be able to afford the payments. This is commonly referred to as “Payment Shock.” Many homeowners overlook Adjustable Rate Mortgages completely for fear of payment shock. There are safety features available for Adjustable Rate Mortgages known as caps. Caps limit the amount your interest rate and payment amount can go up when your lender makes an adjustment or over the lifetime of your loan.
You can learn more about refinancing your mortgage while avoiding costly mistakes with our free mortgage tutorial.
My name is Rob Regehr and I’m a personal finance writer with a chip on my shoulder for banks and brokers that take advantage of my friends and neighbors.
