If you are shopping for a mortgage loan and are considering taking out an adjustable rate mortgage, you need to weigh your options and understand the risk before taking out one of these loans.
Adjustable rate mortgages are also known as variable rate mortgages have an interest rate that changes at regular intervals. Your interest rate changes in accordance with the financial index the loan is tied to. The risks involved come from the interest rate changes and how they affect your monthly payment amount. When the mortgage lender raises your interest rate the monthly payment will go up with it and you may not be able to afford the payments.
The advantage of this type of loan is that if rates fall, your monthly payment will go down. Adjustable Rate Mortgages typically come with an introductory interest rate that is fixed for a period of time. This introductory rate is usually much lower than the actual interest rate and the lender will adjust this rate at the end of the introductory period. If you have little tolerance for financial risk, you are probably better of with a fixed rate mortgage. This allows you to budget for you mortgage payment as you will always know the payment amount.
If you decide an Adjustable Rate Mortgage is right for you, you will want a loan that has caps to protect you from excessive rate and payment hikes. Make sure your loan has both interest rate and payment caps; if these caps are not structured properly you could end up with a negatively amortizing loan that grows over time. Choose a mortgage that has the option of converting to a fixed rate loan if your needs change in the future. To learn more about your mortgage options, including common mistakes to avoid, register for our free mortgage guidebook: “Mortgage Loans: Five Things You Need to Know.”