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Adjustable Rate Mortgages
by rebuildcreditscores.com
by rebuildcreditscores.com
Unfortunately, many consumers have been negatively affected by the sub-prime mortgage
crisis which centers around ARM loans. Whilethe lower initial interest rate of ARM loans affords
the opportunity of homeownership to more people, that homeownership comes with greater
risks.
When considering an adjustable rate mortgage loan it is important that you understand your
options before you sign any loan documentation. Do not trust your mortgage broker, lender or
bank loan officer to fully explain the risks. Do your own research and even consult an attorney
if possible.
Features of Adjustable Rate Mortgages
Index rate. A guide that lenders use to determine interest rate changes. Lenders use many
rate indexes but the most common are one, three, or five-year Treasury Securities. Each
Adjustable Rate Mortgage is linked to a specific index.
Margin. The percentage points or mark-ups that a lender adds to the index rate. The index
rate and margin determines the ARM’s total interest rate. The margin is an interest rate that
represents the lender's cost of doing business along with the profits the lender makes during
the life of the loan.
Initial interest rate. The interest rate on an ARM at its inception. Initial Discounts. Interest
rate concessions that reduce the interest rate below the current rate usually offered for the
first year of the loan.
Adjustment period. The period of time where the ARM interest rate remains unchanged.
At the end of the adjustment period the interest rate resets and the monthly mortgage payment
is recalculated. When you see an ARM described (1-1); (3-1); and (5-1), the first number
denotes the initial period of the loan where your interest rate will stay the same as the day of
the inception of the loan. The second number denotes how often adjustments can be made to
the interest rate after the initial period has ended.
Interest rate caps. Rate caps limit how much the interest rate or monthly mortgage payment
can be changed at the end of the adjustment period. Adjustable Rate Mortgages have two
types of interest rate caps: (1) Periodic Caps which limit the amount interest rates can increase
from one adjustment period to another and (2) Overall Caps which limit the amount an interest
rate can increase over the life of the loan.
Payment caps. Limits on how much a monthly mortgage payment can increase at each
adjustment period. Borrowers should take note that payment caps without corresponding
interest caps can result in negative amortization where the unpaid interest portion is added to
the outstanding balance of the loan.
Negative amortization. Basically negative amortization means the mortgage balance is
increasing. The increase in mortgage balance is directly related to the amount of deficiency in
interest payment due on the mortgage. This occurs whenever the monthly mortgage payments
are not large enough to pay all the interest due on the mortgage. When negative amortization
occurs, you not only add to the balance of the loan but that interest added to the balance
generates even more interest debt.
Conversion. A clause in the loan which allows the borrower to convert an Adjustable Rate
Mortgage to a Fixed Rate Mortgage (FRM) at a designated time.
Prepayment. A clause in the loan agreement that requires the borrower to pay special fees
or penalties to pay off the ARM loan early. These penalties are often steep but they can be
negotiated.
Discounted rates and buydowns. An upfront fee that allows the lender to offer an initial
lower interest rate than the sum of the index and the margin. Buydown rates eventually expire
and your payments could significantly rise.
Option ARM. Adjustable Rate Mortgages which provide borrowers “flexibility” or “options” in
making monthly payments. The rate adjusts monthly and is based on the index added to the
margin rate. Some of the options in payment are: Interest Only; Fully Amortizing 30-Year
Payment; Fully Amortizing 15-Year Payment and Minimum Payment. Option Arms contain a
variety of rate adjustments that depend on indexes increasing or decreasing. The advantage
in an Option ARM is that the borrower has the ability to choose which type of payment he or
she makes depending on their financial condition in a given month. One of the main
disadvantages is that the borrower may end up with negative amortization.
Some of the most common rate indexes are the Constant Maturity Treasury (CMT), Cost of
Funds Index (COFI), 12-month Treasury Average Index (MTA), Bank Bill Swap Rate (BBSW)
and the London Interbank Offered Rate (LIBOR).
crisis which centers around ARM loans. Whilethe lower initial interest rate of ARM loans affords
the opportunity of homeownership to more people, that homeownership comes with greater
risks.
When considering an adjustable rate mortgage loan it is important that you understand your
options before you sign any loan documentation. Do not trust your mortgage broker, lender or
bank loan officer to fully explain the risks. Do your own research and even consult an attorney
if possible.
Features of Adjustable Rate Mortgages
Index rate. A guide that lenders use to determine interest rate changes. Lenders use many
rate indexes but the most common are one, three, or five-year Treasury Securities. Each
Adjustable Rate Mortgage is linked to a specific index.
Margin. The percentage points or mark-ups that a lender adds to the index rate. The index
rate and margin determines the ARM’s total interest rate. The margin is an interest rate that
represents the lender's cost of doing business along with the profits the lender makes during
the life of the loan.
Initial interest rate. The interest rate on an ARM at its inception. Initial Discounts. Interest
rate concessions that reduce the interest rate below the current rate usually offered for the
first year of the loan.
Adjustment period. The period of time where the ARM interest rate remains unchanged.
At the end of the adjustment period the interest rate resets and the monthly mortgage payment
is recalculated. When you see an ARM described (1-1); (3-1); and (5-1), the first number
denotes the initial period of the loan where your interest rate will stay the same as the day of
the inception of the loan. The second number denotes how often adjustments can be made to
the interest rate after the initial period has ended.
Interest rate caps. Rate caps limit how much the interest rate or monthly mortgage payment
can be changed at the end of the adjustment period. Adjustable Rate Mortgages have two
types of interest rate caps: (1) Periodic Caps which limit the amount interest rates can increase
from one adjustment period to another and (2) Overall Caps which limit the amount an interest
rate can increase over the life of the loan.
Payment caps. Limits on how much a monthly mortgage payment can increase at each
adjustment period. Borrowers should take note that payment caps without corresponding
interest caps can result in negative amortization where the unpaid interest portion is added to
the outstanding balance of the loan.
Negative amortization. Basically negative amortization means the mortgage balance is
increasing. The increase in mortgage balance is directly related to the amount of deficiency in
interest payment due on the mortgage. This occurs whenever the monthly mortgage payments
are not large enough to pay all the interest due on the mortgage. When negative amortization
occurs, you not only add to the balance of the loan but that interest added to the balance
generates even more interest debt.
Conversion. A clause in the loan which allows the borrower to convert an Adjustable Rate
Mortgage to a Fixed Rate Mortgage (FRM) at a designated time.
Prepayment. A clause in the loan agreement that requires the borrower to pay special fees
or penalties to pay off the ARM loan early. These penalties are often steep but they can be
negotiated.
Discounted rates and buydowns. An upfront fee that allows the lender to offer an initial
lower interest rate than the sum of the index and the margin. Buydown rates eventually expire
and your payments could significantly rise.
Option ARM. Adjustable Rate Mortgages which provide borrowers “flexibility” or “options” in
making monthly payments. The rate adjusts monthly and is based on the index added to the
margin rate. Some of the options in payment are: Interest Only; Fully Amortizing 30-Year
Payment; Fully Amortizing 15-Year Payment and Minimum Payment. Option Arms contain a
variety of rate adjustments that depend on indexes increasing or decreasing. The advantage
in an Option ARM is that the borrower has the ability to choose which type of payment he or
she makes depending on their financial condition in a given month. One of the main
disadvantages is that the borrower may end up with negative amortization.
Some of the most common rate indexes are the Constant Maturity Treasury (CMT), Cost of
Funds Index (COFI), 12-month Treasury Average Index (MTA), Bank Bill Swap Rate (BBSW)
and the London Interbank Offered Rate (LIBOR).
Adjustable Rate Mortgage (ARM) is a
mortgage loan which allows the lender to
make interest rate adjustments by
referring to a national index.
The major advantage of an ARM to the
borrower is greater affordability. The
interest rate is lower than the market rate
at the inception or first few years of the
loan.
The ARM loan has caps on interest rate
adjustments, annually and over the life of
the loan.
mortgage loan which allows the lender to
make interest rate adjustments by
referring to a national index.
The major advantage of an ARM to the
borrower is greater affordability. The
interest rate is lower than the market rate
at the inception or first few years of the
loan.
The ARM loan has caps on interest rate
adjustments, annually and over the life of
the loan.
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