With
an ARM (see below) rates change periodically, tracking the overall
economy and this enables lenders to charge lower initial rates.
Most people change their loans, either by selling their home or
refinancing it, and have thereby paid more for their mortgage
than necessary.
Adjustable
Rate Mortgage (ARM)
Loans are more complex, as they have two components that determine
the interest rate, the index and the margin. The index is the
rate of a short term maturity, such as the Treasury bond or 6
month certificates of deposit. The margin is a static value, usually
between 2 and 3%, which is added to the index to produce the fully
indexed rate, which is the one you pay. The amount that the interest
rate can change is limited to protect the consumer. It can usually
only increase 2% per year and 6 % over the entire life of the
loan. Start rates for ARM’s are typically significantly
lower than for Fixed Rate loans. It is not guaranteed that the
rate will go up, it can stay the same and in some cases decrease
depending on financial market changes.
It
is important to discuss and fully understand the following factors
when considering an
Adjustable Rate Mortgage loan. Be sure to address each with your
loan officer before deciding to apply for one. These factors are:
Adjustment
Period A predetermined period of time. At the end of
this interval the interest rate is adjusted, based on the index.
Typically, this is an annual event.
Index The Standard used to track the change in the economy that
will determine the direction and degree of rate change. Some indexes
are less volatile than others.
Margin The percentage that will be added to the index to obtain
the rate that your loan interest will adjust too.
Annual Cap The maximum amount the interest rate
can increase per year.
Lifetime Cap The maximum amount the interest rate can increase
over the life of the loan.
Hybrid Loans Hybrid ARM’s provide homeowners with a unique
advantage because they adjust like an ARM but have an initial
fixed rate from 1, 3, 5 or 7 years. Often they are advertised
an 5/1 or 7/1 ARM’s. This can be “decoded” as
meaning fixed for 5 or 7 years and then adjusting once every year.
Its popularity is increasing, as borrowers become more knowledgeable
of the mortgage market. The start rate increase proportionally
with the length of the initial fixed period.
Interest Only Loans
As the name implies, these are loans that are designed to have
only the interest generated by the loan paid on a monthly basis.
A “fully Amortized” loan, which is the traditional
mortgage type, requires both the interest and principle to be
paid each month. By only collecting the interest due each month,
the monthly payments are reduced. This loan appeals to those who
are interested in maximizing their available funds each month.
It is also an excellent way to qualify for a higher loan amount
as the lower payments will result in a lower overall debt-to-income
ratio, often allowing a higher loan amount
Optional
Payment Flexibility is the key here!. Each month the
lender informs the borrower of three optional payments. First,
there is the normal principle and interest payment, which if paid
each month would result in a gradual decrease in the loan balance.
Then there is the interest only payment which pays the interest
due for the month and leaves the loan balance constant. Finally
there is the deferred interest (negative amortization) payment.
The deferred interest payment is based on an artificially low
interest rate. The payment is not enough to pay the full interest
earned for the month. The unpaid interest is added to the loan
balance. Each time this option is selected, the principle amount
of the loan increases.
Balloon
Payment
After making payments for an agreed upon period of time, the entire
loan balance becomes due and payable. There is the possibility
of refinancing the loan at the time the balloon payment is due,
but the lender is under no obligation to refinance the loan. It
is extremely important that the borrower understands all of the
term of this and any other loan type.
