An adjustable rate mortgage (hybrid/ARM), is a loan with an interest rate linked to an economic index. The interest rate, and your payments are periodically adjusted ^ up or down v as the index changes. Lenders generally offer lower rates on ARM loans because they have the ability to adjust the rate you pay to changing market conditions. Understanding how this product works can help determine whether the savings are worth the risk for you.
ARM Terminology:
Index: A guide that lenders use to measure interest rate changes. Each ARM is linked to a specific index. There are well over 100 index's however Libor, MTA & COFE are among the most popular with the mortgage industry.
Margin: An interest rate that represents the lender's cost of doing business plus the profit they will make on the loan. The margin is added to the index rate to determine your total interest rate. It usually stays the same during the life of your home loan.
Adjustment Period: The period between potential interest rate adjustments. You may see ARM's described as 3-1-5, 5-2-7 & 7-3-10 etc.
The first figure refers to the initial period of the loan which your interest rate will remain as stated on your loan papers. In these examples that's 3, 5 & 7 years. This can be referred to as the recast period.
The second number shows how much your rate can increase after the initial fixed period. The examples above are 1%, 2% & 3%. In general prime loans may adjust 1 to 1-1/2% every 12 months & subprime can adjust 1-1/2 to 3% every 6 months after the fixed period expires.
The third number is the lifetime cap. It's the maximum your rate can change during the life of your loan. In the above examples that's 5, 7 & 10% caps. Lifetime caps have been required by law since 1987.
If my payments can go up, why should I consider an ARM?
What goes up may go down. While we are used to thinking of ARM rates as only rising, index's can move in either direction. There is much debate today regarding the future direction of the economy & inflation which drive index rates.
The initial interest rate for an ARM is lower than that of a fixed rate mortgage, where the interest rate remains the same during the life of the loan. A lower rate means lower payments, which might help you qualify for a larger loan.
How long do you plan to own the house? A rate increase isn't as much of a concern if you plan to sell the home within a few years.
Do you expect your income to increase? If so, the extra funds might cover the higher payments that result from rate increases permitting you to purchase more home today vs. chasing tomorrow's higher prices.
Do you know the periodic & lifetime caps of your ARM Loan? Do you know if its prime or sub-prime paper? I would be happy to review your current loan documents without obligation and assist you in making an educated decision regarding what's best for you.
Greg Zaccagni @ http://www.mortgageadvisor.info Visit my blog for other mortgage news
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