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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Use this calculator to determine the Annual Percentage Rate (APR) for your mortgage. Press the report button for a full amortization schedule, either by year or by month.
Definitions
- Annual Percentage Rate (APR)
- A standard calculation used by lenders. It is designed to help borrowers compare different loan options. For example, a loan with a lower stated interest rate may be a bad value if its fees are too high. Likewise, a loan with a higher stated rate with very low fees could be an exceptional value. APR calculations incorporate these fees into a single rate. You can then compare loans with different fees, rates or different terms.
- 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 mortgage terms are 15 years and 30 years.
- Monthly payment
- Monthly principal and interest payment (PI).
- Total payments
- Total of all monthly payments over the full term of the mortgage. This total payment amount assumes that there are no prepayments of principal.
- Total interest
- Total of all interest paid over the full term of the mortgage. This total interest amount assumes that there are no prepayments of principal.
- Loan origination percent
- The percent of your loan charged as a loan origination fee. For example, a 1% fee on a $120,000 loan would cost $1,200.
- Discount points
- Total number of "points" purchased to reduce your mortgage's interest rate. Each "point" costs 1% of your loan amount.
- Other fees
- Any other fees that should be included in the APR calculation. These fees can vary by lender, but at a minimum usually includes prepaid interest.
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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