Understanding adjustable rate mortgages

Shopping for a mortgage can be an extremely confusing process. After you get through the first hurdle of actually picking a mortgage company, there are countless mortgage products to choose from, and even more options within each individual type.

The two most popular types of mortgages are the fixed-rate mortgage and the adjustable-rate mortgage. Certain mortgages are better for some people than others, so it is important to educate yourself on all of the available options.

The August 4, 2005 article from WhittierDailyNews.com, “Deciphering ARM, fixed-rate mortgages,” by Robert K. Heady gives some insight into the two most popular types of mortgages.

“With mortgage rates rising but home prices still going up, what should you do about refinancing or taking out a new home loan? What kind of loan should you get a fixed-rate or an adjustable-rate mortgage? If you go the ARM route, do you understand all the complexities of how that type of borrowing works? Those questions still baffle millions of current and would-be home owners, but there are ways to master the right answers. First, though, you need to know beforehand that if the rate changes and your monthly payment goes up, you can adequately prepare for the higher costs.”

If you are aware of the stipulations within your mortgage contract, you will be able to prepare in advance if the rates go up and your monthly payment increases. It is education such as this that can mean the difference between a foreclosure and a happy home.

There are some important things that must be understood before you choose which type of mortgage is right for you.

“Learning the basics: With a fixed-rate mortgage, the interest rate stays the same during the life of the loan. But with an ARM, the rate changes periodically, usually in relation to an index such as Treasury securities, and payments go up or down accordingly. Lenders generally charge lower initial rates for ARMs than for fixed- rate loans. This makes the ARM easier on your pocketbook at first, and means you might qualify for a larger loan because lenders sometimes make their decision based on your current income and the first year's payments. Also, an ARM could be less expensive than a fixed rate over a long period for example, if interest rates remain steady or decline.”

The adjustment period with an ARM is one of the most important things to understand. Every ARM is different, and there are also different adjustment periods. With an ARM, the rate and the payment change every year, three years or five years. There are some with more frequent changes and some with seven or 10 year periods as well.

There are also discounts available with ARMs.

“Some lenders offer initial ARM rates that are lower than their ‘standard’ ARM rates (that is, lower than the sum of the index rate and the margin). Such rates are often combined with large upfront fees and higher rates after the discount expires. In return, the buyer gets a lower rate and lower payments early in the mortgage term. This is sometimes called a ‘seller buy down,’ but beware the seller may increase the price of the home to cover the cost of the buy down.”

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