Adjustable Rate Mortgage- What Is It?
ARM, the short term for Adjustable Rate Mortgage, is a mortgage plan that adjusts its interest rates after a specified period of time using different factors. Changes in a specific index affect the interest rates in different periods thereby changing the amount of your loan. An index is a specified quantity that is used by money lenders to measure the changes in the interest rates.
One of the primary indexes that are used in Adjustable Rate Mortgage is Treasury bill rate, which is also known as prime rate. The aim of ARM is to match the loan interest rates according to the present market rates. The mortgage holder is protected by a maximum interest rate known as ceiling. Ceiling will be reset annually to make sure the highest possible interest rate. People who use ARM generally enjoy a higher interest rate compared to Fixed Rate Mortgage, generally as a favor for the higher risk they are taking.
Some of the major sources which controls Adjustable Rate Mortgage are Cost Of Funds Index (COFI), London InterBank Offered Rate (LIBOR), Constant Maturity Treasury (CMT), National Average Contract Mortgage Rate and Bank Bill Swap Rate (BBSR). Some countries follow an index which is known as Prime Lending Rate, published by the major banks in their country.
The ceiling is adjusted at the beginning of every financial year so that it covers the highest interest rate as possible. Adjustable Rate Mortgage offers you a higher rate of interest than users of Fixed Rate Mortgage. This is to compensate you for the higher risk that you consider taking.
Initial Interest Rate – This is the beginning interest rate for your ARM. Generally this interest rate is higher.
Adjustment Period – During your adjustment period, your interest rate remain constant. Usually adjustment period is one year. But this varies with different schemes and can be shorter or longer.
An index rate is a major source used to determine the rest of the Adjustable Rate Mortgage rates. The major sources of indexes are COFI, CMT and LIBOR.
The margin represents additional points that are added to an index rate so as to come up with an interest rate for a particular ARM.
At any situation that you do not pay enough money to meet your monthly ARM installment, there is always an increase in the mortgage balance. The fee that you are charged is what is known as Negative Amortization.
There is another form of Adjustable Rate Mortgage known as Conversion ARMs. This allows you to change your ARM into a Fixed Rate Mortgage if you are not satisfied with the outcomes of an ARM. There is Periodic Caps and Overall Caps. Overall Caps determine how much the interest rate can vary up and down while Periodic Caps determine the time period of rate changes. There is Payment Cap which determine the installment amount every month. If you are paying a lower amount even after the interest rate went up due to Payment Cap restriction, this will be carried over to your future installments.
Adjustable Rate Mortgage is a good option for you if you have confidence in the market conditions. There is always a risk factor while taking an ARM. You should be very careful about Negative Amortization as this can pile up your loan amount and you may get heavy monthly installments.
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