A mortgage with a rate that changes over time is called an adjustable rate mortgage, or ARM.
This can be a very good choice for a lot of people.
The mortgage interest rate changes every so often based on an index.
Because the interest rate changes, the amount a borrower has to pay may change over time.
Mortgages with payments that increase over time are sometimes confused with mortgages with rates that change. In a mortgage with graduated payments, the interest rate stays the same, but the payment amounts change.
With an adjustable rate mortgage, most of the risk of the interest rate is taken on by the borrower. When mortgage interest rates go down, it's good for borrowers. On the other hand, when interest rates go up, people who borrow money lose out. Most of the time, these loans are available when fixed-rate mortgages are harder to get.
Terms to Know
Index: The guide that lenders use to measure how interest rates change. Each loan with an adjustable rate is tied to an index.
Margin is the part of the interest rate that makes money for the lender. The interest rate is the sum of the margin and the index rate. The index will change over the life of an adjustable-rate mortgage, but the margin will stay the same.
Adjustment period: The time between changes in the interest rate, usually written as 1-1. The first number shows how long the interest rate will stay the same for the first part of the loan. The second number is the time it takes to get used to it. It shows the number of times that the interest rate can be changed.
Loan Choosing Tips
When choosing an adjustable rate mortgage, the index is one of the most important things to think about. Even though you can't choose which index a lender uses, you can choose a loan and a lender based on the index that will apply to the loan you want.
A lender you are thinking about can tell you how the loan has worked out in the past. The best loan is one with an index that has been stable in the past. When thinking about loans and lenders, you should also think about the margin rate that the lender offers.
Many people who want to get a mortgage wonder what the advantages of an adjustable rate mortgage are, since the payments can go up over time. Most of the time, an adjustable rate mortgage is better than a fixed rate mortgage when the ARM's interest rate is lower than the fixed rate mortgage. Sometimes the possibility of a pay raise doesn't matter much. This is true if you don't plan to live in the house for a long time or if you think your income will go up during the loan period.
Don't use negative amortisation.
When you choose an adjustable rate mortgage, negative amortisation is one of the most important things to watch out for. This can happen when a loan has a limit on payments that keeps them from being enough to cover the mortgage's interest. So, the unpaid interest is added to the loan, making the loan amount go up even though you are still making payments.
With an adjustable-rate mortgage, you can start out with a positive amortisation, but if the interest rate goes up, you could end up with a negative one. The best way to avoid negative amortisation is to not get a mortgage with an adjustable rate and a payment cap.
