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A Guide to Adjustable Rate Mortgage Loans

April 7th, 2016 | ARMs

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A Guide To Adjustable Rate Mortgage Loans


An effective tool used by home buyers, ARM or Adjustable Rate Mortgages, offers a lower interest rate at the beginning of the loan with the risk of a hike in rates shared by the borrower and lender.

An ARM is ideal if you are certain about rising income expectations and short-term home ownership. There are four basic aspects. One is that the initial interest rate is fixed 1-3 percentage points lower than fixed rate mortgages. Secondly, there is what is known as adjustment interval, when after the initial fixed rate period has elapsed and the rate is modified in keeping with prevalent rates. Third, an index against which lenders can measure the difference between the interest earned on the loan and what would be earned in actuality in other investments. And, fourth, the component added by the lender to the index, usually 1.5-2.5 percent.

An ARM has, in addition, safeguards like interest rate caps. This limits the amount of interest rate that can be applied to the payment during adjustment. Often this cap would be about 2% point cap over the life of the loan.

An ARM is ideal when it lends you buying power in your given situation and goals. You can opt to buy a property with a higher value and still pay a lower initial monthly payment. If you know for certain that you will reside in the house you are buying for a maximum of 5-7 years then ARM is the mortgage that will save you money. If you are prepared to take the risks then ARM offers the greatest possible savings especially if the rate stays steady or declines over the years.

An ARM is a calculated risk as there are no certainties.  However, if at the end of five years your plans change and you are about to continue in the same home for another 10 years, then it is prudent for you to switch from your ARM mortgage to a fixed rate mortgage.

 

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