These loans generally begin with an interest rate that is 2-3
percent below a comparable fixed rate mortgage, and could allow
you to buy a more expensive home. However, the interest
rate changes at specified intervals (for example, every year)
depending on changing market conditions; if interest rates
go up, your monthly mortgage payment will go up, too. However,
if rates go down, your mortgage payment will drop also.
There are also mortgages that combine aspects of fixed
and adjustable rate mortgages - starting at a low fixed-rate
for seven to ten years, for example, then adjusting to market
conditions. Ask your mortgage professional about these and
other special kinds of mortgages that fit your specific financial
situation
Most adjustable rate loans (ARMs) have a low introductory
rate or start rate, some times as much as 5.0% below the current
market rate of a fixed loan. This start rate is usually good
from 1 month to as long as 10 years. As a rule the lower the
start rate the shorter the time before the loan makes its first
adjustment. Index - The index of an ARM is the financial
instrument that the loan is "tied" to, or adjusted
to. The most common indices, or, indexes are the 1-Year Treasury
Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month
Certificate of Deposit (CD) and the 11th District Cost of
Funds (COFI). Each of these indices move up or down based
on conditions of the financial markets.
Margin - The margin is one of the most important aspects
of ARMs because it is added to the index to determine the
interest rate that you pay. The margin added to the index
is known as the fully indexed rate. As an example if the current
index value is 5.50% and your loan has a margin of 2.5%, your
fully indexed rate is 8.00%. Margins on loans range from 1.75%
to 3.5% depending on the index and the amount financed in
relation to the property value.
Interim Caps - All adjustable rate loans carry interim
caps. Many ARMs have interest rate caps of six-months or a
year. There are loans that have interest rate caps of three
years. Interest rate caps are beneficial in rising interest
rate markets, but can also keep your interest rate higher
than the fully indexed rate if rates are falling rapidly.
Payment Caps - Some loans have payment caps instead of
interest rate caps. These loans reduce payment shock in a
rising interest rate market, but can also lead to deferred
interest or "negative amortization". These loans
generally cap your annual payment increases to 7.5% of the
previous payment.
Lifetime Caps - Almost all ARMs have a maximum interest
rate or lifetime interest rate cap. The lifetime cap varies
from company to company and loan to loan. Loans with low lifetime
caps usually have higher margins, and the reverse is also
true. Those loans that carry low margins often have higher
lifetime caps.
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