Adjustable Rate Mortgages | Still a Risky Choice
Adjustable Rate Mortgages Have Lower Rates, But
With interest rates on fixed-rate mortgages rising in recent months, an adjustable-rate mortgage (ARM) still does not make sense.
According to the Mortgage Bankers Association, adjustable-rate mortgage loan applications now account for only 7 percent of all mortgages.
Adjustable-rate mortgages only make sense for home-buyers when the spread between a fixed-rate mortgage and an adjustable-rate mortgage increases to the point that there are significant savings in payments. In today's market adjustable rate loans might actually have higher interest rates than fixed rate loans and are far riskier.
Tolerance for Risk
Experts suggest that the type of adjustable-rate loan a borrower selects should be based on that individual's tolerance for risk. That is, the ability to handle payment increases. Longer-term adjustable-rate loans where the rate is fixed for the first five or seven years lower that risk.
What to do
If you are in the market for an adjustable-rate mortgage, here's what some experts say you should do:
Find out if the loan rate adjusts monthly, semiannually, or annually. Some mortgages only adjust once during the entire life of the mortgage. Most adjustable rate mortgages (ARM), however, are adjusted annually after an initial fixed period of one, three, five, seven, or even ten years.
Determine how high the interest rate can be raised. This is called a cap. Most common are mortgages with 2/6 caps for shorter terms and 2/5 for longer terms. The first number refers to the maximum percentage increase at each adjustment period. The second refers to the maximum interest rate increase during the lifetime of the loan.
Index and Margin
Ask exactly how your interest rate will be determined. There are two parts to each adjustment: the index and the margin. First, all interest rate adjustments start with an index. The most common index is the one-year Treasury Bill Index that is an average of the previous four weeks' one-year Treasury bill rates.
The second part of the adjustment is the margin. This amount will be added to the index to compute your interest rate for the adjustment period. Margins can vary from 2 percent to 3.5 percent. A higher margin can mean a higher interest rate.
All lenders are required to give you an adjustable disclosure booklet describing adjustable-rate loans and how they work. Be sure to read this information before you apply for a mortgage.
Also ask for a disclosure on the type of mortgage you are considering. It will provide the details of what you can expect to happen when interest rates adjust.
Some adjustable-rate mortgages carry an option to convert to a fixed-rate mortgage at some future date. You might pay more for a conversion option, but there is no real advantage to a convertible mortgage because of the low cost of refinancing."
And one last piece of advice:
Adjustable-rate mortgage loans can be very complicated because of all the variables. Do not accept verbal promises from the lender's agent without also getting all the details in writing. Also, be sure to deal with a lender that will be around if something goes wrong.
If after reading the material provided to you, you still don't understand something, ask questions.
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