What is an Adjustable Rate Mortgage Loan?
The adjustable-rate mortgage loan is not something to automatically turn away from and is often misunderstood, especially with its misconstruction in the media and its general misuse by the public. Taking advantage of an ARM loan in the right circumstance can indeed save you a substantial amount of money on interest. However, using it improperly can cause a slew of financial issues, including the foreclosure of your home. Here is a quick look at the adjustable-rate mortgage.
Defining the Adjustable-Rate Mortgage
As the name indicates, an adjustable-rate mortgage loan is a type of loan that has a rate that changes depending on a predetermined rate. This causes your monthly payments to increase and decrease depending on the rate at the time of the adjustment. This type of loan is different than a fixed-rate mortgage as it comes with the same rate for the length of the loan.
Pros of the Adjustable-Rate Mortgage
In most cases, you’ll start with a lower interest rate than with a fixed mortgage loan. If the interest rate then stays put or even decreases during the length of your loan it could allow you to save money.
Cons of the Adjustable-Rate Mortgage
This type of loan is unpredictable once it enters into its adjustment period since you can never predict exactly how it’ll adjust. You always run the risk of this type of loan increasing during its adjustment. Naturally this will then increase the amount you have to pay each month on it.
Scenarios Where Adjustable-Rate Mortgages Make Sense
In some scenarios, adjustable-rate mortgage loans can end up saving you money. If your plan is to remain in your house for only a few years, then you may be able to secure the lower interest rate through an ARM loan rather than a fixed-rate mortgage. For instance, if you plan on remaining in your home for three years you could choose a 3/1 ARM in order to secure a lower interest rate. If you then move after the three-year period and sell your home, you’ll still be within the initial rate period, and so the rate would not be changed. Essentially, you will be able to maintain your mortgage during the fixed period and then sell the home before the interest rate adjusts. However, keep in mind that this strategy requires that you be able to sell your home.
Scenarios in Which Adjustable-Rate Mortgages Do Not Make Sense
If you are planning on remaining in your home for an extended period, then you’ll benefit more from a fixed-rate mortgage. Although you’ll have to deal with a higher interest rate in the first couple of years compared with an adjustable-rate mortgage, your rate will never move. This means that you mortgage payments will stay constant throughout the term of your loan. On the other hand, if you utilize an adjustable-rate mortgage loan in the long-term, you’ll have to deal with interest that changes periodically, and usually upwards instead of downwards.
Common ARM Loans
The majority of ARM loans are a type of hybrid loan. This is because they start with a fixed rate and then the rate adjusts. It is typical that these loans are labeled with a number that indicates the fixed-rate period in years and then indicates how often the payment and interest rate changes. For instance, a 3/1 ARM will start out with a fixed rate in the first three years of the loan. After which time it will change each year.
What is a Rate Cap?
This term is also sometimes called an interest rate cap. It is a feature that caps off the amount that your interest rate increases. There are two kinds of rate caps one is for the loans lifetime, and the other is periodic. The periodic adjustment cap determines the maximum amount that the rate can increase from a single adjustment period. The lifetime cap defines how much the loan can increase over its life span.