When considering an adjustable rate mortgage, what may appear affordable now, may become financial disaster later. Before signing, make sure you understand when your adjustment is going to happen and whether or not you will be able to afford it when it does.
An adjustable rate mortgage, commonly known as an ARM is typically used for those borowers who have had a bruised credit situation and are needing a 2-3 year loan while they repair their credit issues.
ARMs are never meant to be used as long term loans. Those who know they will be obtaining a new mortgage prior to the adjustment date will benefit from the lower interest rate an ARM can give. An ARM can be beneficial for someone who is planning to relocate or who's property is in a transition state.
While a lot has been written in the press about the need to move to 30 year fixed mortgages, statistical analysis of historical differences between adjustable and fixed rate mortgages does bear out that ARM type mortgages, when utilized properly, unilaterally beat out 30 year fixed mortgages in terms of interest paid over a 30 year period.
ARM products come in many shapes and sizes, and many offer fixed rates for 10 or even 15 years, along with inexpensive interest only and even lower minimum payment options. In fact, the ARM type mortgage has been the loan of choice for wealthy, high net worth individuals for years, because it allows them to maximize their cashflow over the short term and take advantage of frequent changes in short term interest rates.
A commonly used Adjustable Rate Mortgage (ARM) is a hybrid of a Fixed Rate Mortgage (FRM) and the traditional Adjustable Rate Mortgage. These type of ARM has an initial fixed rate period of 2, 3 or 5 years. Thereafter the mortgage loans become an ARM and have adjustable rates for the remainder of the loan term.
Adjustable Rate Mortgages can serve a purpose only if you plan on selling the home before the adjustment period ends. Unfortunately, a lot of mortgage brokers sell Adjustable rate mortgages to people that plan on being in a home for longer periods of time. This can be very dangerous. Adjustable rate mortgages can and will go up. Most of the time they go up by the maximum allowed. This could mean that on the anniversary of your mortgage, your rate can go up by as much as 2%
Considering the fact that most American homeowners sell or refinance their home every 4-5 years is a good reason to possibly consider an ARM loan. An ARM loan can provide an optimal interest rate and a low payment for a loan that you will probably not be in for a long term. There are many different factors that need to be weighed though when considering an ARM loan. Some of these factors will be: Is this home just a starter home or where you want to remain for the next decade+? What is the stater rate on the ARM, what is the index and what is the margin (these are all very important facts to ask and find out about)? What are the caps on the ARM loan (in other words, what is the most the rate can go up or down each adjustment period and over the life of the loan)? What are the differences between the ARM rate now and the fixed rate now (sometimes the difference in rate may be so minimal that it makes more sense to just go with the fixed rate)?