What is an Adjustable Rate Mortgage?

Published by julia | Filed under Buyer / Seller Tips, Market Trends, Pinellas County Homes, Real Estate

A common type of home loan is the adjustable rate mortgage (or ARM). With this type of loan, the interest rate fluctuates depending on the current prime interest rate, as determined by the various real estate indexes.

The interest rate changes over the course of the loan, so the lender gets a proper margin. That’s due to the fact that the indexes influence the cost of funding the loan. Essentially, your lender lets you take on a little bit of the
interest risk instead of that risk being placed on just the lender, as it is in a fixed rate loan. This type of loan can save you a lot of money if the interest on your home loan consistently falls for a long period of time. However, if interest rates rise, your payment can go up significantly, which is what happened to a lot of people during the current foreclosure crisis. Their adjustable rate mortgage payments went up more than they could afford.

However, most lenders of adjustable rate mortgages put caps on how much your monthly mortgage payment can rise. As an example, let’s say a lender gives you an adjustable rate mortgage. It has a 1 percent cap for any 6 month time frame and a 4 percent total cap for the entire loan. Your payments can increase as much as 4 percent at the maximum until the loan is paid off. That’s not too bad, as your payments won’t increase that much, even if interest rates rise more than 4 percent. However, many of the sub-prime lenders responsible for the foreclosure crisis did not place caps on their loans, which lead to the many foreclosures happening these days.

Every area in the country has different interest rates, so you should read up on it before you opt to go with an adjustable rate mortgage. Be sure your lender offers a cap, as well. Otherwise, you’ll be better off with a regular, fixed rate mortgage. Local newspapers and some websites online often include interest rates and predictions so these are great places to go to keep an eye on things and decide if an adjustable rate mortgage is right for you.

Related reading: Tampa Mortgage and Finance