Facts About ARM's, Adjustable Rate Mortgages  What is an ARM?
An Adjustable Rate Mortgage, called an ARM for short, is a mortgage with an interest rate that is linked to an economic index. The interest rate, and your payments, are periodically adjusted up or down as the index fluctuates.
ARM Terminology
Index
An index ia a guide that lenders use to measure interest rate changes. Common indexes used by lenders include the activity of one, three, and five-year Treasury securities, but there are many others. Each ARM is linked to a specific index.
Margin
Think of the margin as the lender's markup. It is an interest rate that represents their 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 the loan.
Adjustment Period
The adjustment period is the period between potential interest adjustments.
• You may see an ARM described with figures such as 1-1, 3-1, and 5-1.
The first figure in each set refers to the initial period of the loan, during which your
interest rate will be the same as it was on the day of closing.
• The second number is the adjustment period, showing how often adjustments can be
made to the rate after the initial period has ended. The examples above are all ARMs
with annual adjustments.
If my payments can go up, why should I consider an ARM?
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.
More ARM Considerations
• How long do you plan to own the house? The possibility of higher rates isn't as much
of a factor if you plan to be in the home for a relatively short time.
• Do you expect your income to increase? If so, the extra funds might cover the higher
payments that result from rate increases.
• Some ARMs can be converted to a fixed-rate mortgage. However, conversion fees may
be high enough to take away all of the savings you saw with the initial lower rate.
• While you can't dictate which index a lender uses, you can choose a lender based on
the index that will apply to your loan. Ask how each index used has performed in the
past. Your goal is to find a loan linked to one that has remained fairly stable.
• When comparing lenders, consider both the index and the margin rate being offered.
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A balloon mortgage can be an excellent option for many home buyers. A balloon mortgage is usually rather short, with a term of five to seven years, but the payment is based on a term of 30 years. They often have a lower interest rate, and can be easier to qualify for than a traditional 30 year fixed mortgage. There is, however, a risk to consider. At the end of your loan term you will need to pay off your outstanding balance. This usually means you must refinance, sell your home or convert the balloon mortgage to a traditional mortgage at the current interest rates.
Definitions
- Mortgage amount
- Original or expected balance for your mortgage.
- Interest rate
- Annual interest rate for this mortgage.
- Term in years
- The number of years over which you will repay this loan. The most common balloon mortgage terms are 5 years and 7 years. After the mortgage term is complete, you will then need to refinance or pay off the remaining balance.
- Monthly payment
- Monthly principal and interest payment (PI). The monthly payment is calculated using a 30 year term.
- Total payments
- Total of all monthly payments over the term of the balloon mortgage. This total payment amount assumes that there are no prepayments of principal.
- Total interest
- Total of all interest paid over the term of the balloon mortgage. This total interest amount assumes that there are no prepayments of principal.
- Prepayment type
- The frequency of prepayment. The options are: none, monthly, yearly, and one-time payment.
- Prepayment amount
- Amount that will be prepaid on your mortgage. This amount will be applied to the mortgage principal balance, based on the prepayment type.
- Start with payment
- This is the payment number that your prepayments will begin with. For a one time payment, this is the payment number that the single prepayment will be included in. All prepayments of principal are assumed to be received by your lender in time to be included in the following month's interest calculation.
- Savings
- Total amount of interest you will save by prepaying your mortgage.
The mortgage calculators are provided by KJE Computer Solutions, LLC and made available to NUMBER1EXPERT as self-help tools for your independent use and are not intended to provide investment advice. We can't guarantee their applicability or accuracy in regards to your individual circumstances. All examples are hypothetical and are for illustrative purposes. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. |
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