Adjustable-rate mortgages are a popular way for first-time homebuyers to get the money they need to buy a house. The borrower might not understand terms like rising interest rates and other changes.
Loans with rates that change are called adjustable rate mortgages (ARMs). Loans with an adjustable interest rate will go up and down with interest rates. A consumer might choose an ARM for many reasons, but they can be risky loans.
A consumer might choose an adjustable-rate mortgage because the rates are usually lower at first than with a fixed-rate loan. If you only plan to live in the house for a short time, say 5 years, an ARM with fixed payments for the first 5 years can be a good choice.
Lenders mostly offer three main types of ARM loans. Among them are:
A 5/1 ARM loan is one where the payment stays the same for 5 years and then changes for the next 25.
When you get a 3/1 loan, the payments stay the same for the first three years and change after that.
The 2/1 ARM is set for two years and can be changed for the next 28.
This is how a mortgage with a rate that changes works. It is usually set for a certain amount of time at first, which could be anywhere from one month to five years. After this time, the loan's interest rate will change based on a published "index," like the LIBOR Prime rate, the Cost of Funds Index, or another index, plus a margin, which is the lender's profit. If the index goes up, so does your rate. If it goes down, your rates should go down too. The total amount that the interest can go up over the life of the loan is limited.
What happens when the mortgage rate goes up all of a sudden?
When it comes to how to deal with higher rates, you have a few options.
Most people choose to switch to a mixed-rate mortgage. This is a good choice if you have built up enough equity and can pay the higher payments. Watch out for penalties if you pay off your mortgage early. Make sure you understand how the costs of refinancing will affect your loan.
You could also talk to a trustworthy credit counsellor. They might be able to help you lower your payments and put off paying the interest on what you still owe. This will add to the amount you owe on your loan, though. Try to come up with a way to pay less on your other debts to make up for the higher mortgage payment. Or, talk to your lender and try to get them to agree to a forbearance or delay the increase until you can pay.
You could also sell it. Put it on the market with a real estate agent if you have enough money to cover commissions and other costs. Or sell it on your own. In a deed-in-lieu-of-foreclosure agreement, you give your house to the lender. You won't get any money for your equity, and it will hurt your credit score.
Foreclosure is an option, but it's not something you want to do. Doing nothing is the worst thing you can do.
If you choose a mortgage with an adjustable rate, you should know that the rate could go up over the life of the loan. Your payments may go up, and you may have to change how you handle your other debt. If you only plan to live in the house for a short time, an ARM could be the best way to pay for it.
