Adjustable Rate Mortgage

ADJUSTABLE RATE - ARM MORTGAGES

Adjustable-rate mortgages (ARMs) have an interest rate that may change periodically depending on changes in a corresponding financial index that’s associated with the loan. When the rate changes, generally, your monthly payment will increase if rates go up and decrease if rates fall.

Most lenders today offer a “hybrid ARM,” or “fixed-period ARM,” which features an initial fixed interest rate period, typically of 3, 5, 7 or 10 years. After the introductory fixed-rate period expires, the interest rate becomes adjustable for the remainder of the loan term. The overall term for Midwest Mortgage Capital hybrid ARM loans is 30 years. These loans are named by the length of time the interest rate remains fixed and how often the interest rate is subject to adjustment thereafter.

For example, in a 5/1 ARM, the “5” stands for a 5-year introductory period in which the interest rate remains fixed. The “1” shows the interest rate is subject to adjustment once per year after the introductory period expires.

How an adjustable-rate mortgage impacts payments.

With a hybrid ARM, the interest rate during the introductory period is often lower, which could mean a lower starting monthly payment. However, at the end of the introductory fixed-rate period, the loan’s interest rate will adjust to a fully indexed rate, and your rate and your monthly payments may increase. If that happens, you’ll want to be financially prepared to make larger payments.

Similarly, once a year after the introductory period is over and for the remainder of the loan’s term, your rate—and monthly payment—could go up or down.

Things to consider

Hybrid adjustable-rate mortgages are a good choice if you:
  • Are planning to move in a few years (before the end of the introductory fixed-rate period) and therefore aren’t concerned about possible rate increases
  • Expect your income to rise enough in the coming years to cover any increase in payments resulting from an increase in the interest rate
  • Want a lower initial monthly payment than a fixed-rate mortgage usually offers
  • Think interest rates may go down in the future

Some disadvantages of a hybrid adjustable-rate mortgage:
  • Interest rates will increase in a rising rate environment
  • An increase in rates will increase your payment amount, which may not keep pace with an increase you may have in income
  • An increase in interest rate will reduce the accumulation of  equity, especially where home values are declining, and may make it more difficult to refinance your loan

Types of hybrid ARMs

10/1 adjustable-rate mortgage

A 10/1 ARM loan has a fixed interest rate for the first 10 years. After 10 years, the rate can change once every year for the remaining life of the adjustable-rate mortgage. When the rate changes, your monthly payments will increase if rates go up and decrease if rates fall.

7/1 adjustable-rate mortgage

A 7/1 ARM loan has a fixed interest rate for the first 7 years. After 7 years, the rate can change once every year for the remaining life of the adjustable-rate mortgage. When the rate changes, your monthly payments will increase if rates go up and decrease if rates fall.

5/1 adjustable-rate mortgage

A 5/1 ARM loan has a fixed interest rate for the first 5 years. After 5 years, the rate can change once every year for the remaining life of the adjustable-rate mortgage. When the rate changes, your monthly payments will increase if rates go up and decrease if rates fall.

ARM loan indices and interest rate caps

The interest rate you pay on a hybrid adjustable-rate mortgage after the introductory fixed rate expires is based on a fluctuating financial index plus a margin. Your monthly payments will increase if rates go up and decrease if rates fall. For example, if the interest rate for the financial index is 5.5% and your margin is 2.25%, then your rate at the time of adjustment would be 7.75%. Keep in mind that different indexes go up and down faster than others, and both the index used and the margin can vary among lenders. How often your payments are adjusted based on the index, and how much rates and payments increase at each adjustment, depends on your adjustable-rate mortgage terms.

Hybrid (as well as traditional) ARM loans typically feature an adjustment “cap,”  which limits how much the interest rate can go up or down in any new adjustment period and/or over the life of the loan. However, many rate caps allow significant monthly payment increases that could result in “payment shock.” After the introductory fixed-rate period, the interest rate for ARM loans adjusts once per year.

When finding out about ARM options, be sure to ask the following questions:
  • Does the ARM loan you’re considering include a rate cap? If yes, what is the rate cap per adjustment period and over the life of the loan?
  • How often is the rate subject to change?
  • Is your ARM loan assumable ?
  • Are there any penalties for paying off your loan early, also called a prepayment fee? Being able to prepay your adjustable-rate mortgage will allow you to refinance if rates go down.

Financial indices

Every adjustable-rate mortgage loan uses a money rate index to determine the loan rate for a set period. Lenders have no control over any of the money rate indices. You can track the performance of each index in The Wall Street Journal. The rate you pay is set at each adjustment period by adding the rate of the index plus your  margin  (which remains the same from period to period). Below are some common indices on which adjustable-rate mortgages are based.

Even though rate indices may adjust more frequently than every year, Bank of America adjustable-rate mortgages do not adjust more frequently than once a year.
Treasury-indexed adjustable-rate mortgages (T-Bills)

These track the weekly average yield of U.S. Treasury securities adjusted to a constant maturity of 6 months or 1 year. The interest rate on an ARM loan from Midwest Mortgage Capital will adjust once each year. Per-adjustment caps and lifetime rate caps vary.

London Interbank Offered Rate (LIBOR) adjustable-rate mortgages

The LIBOR index tracks the rate international banks charge each other for large loans in the London interbank market. This adjustable-rate mortgage adjusts to the LIBOR annually based on the 1-year U.S. dollar–denominated deposits in the London market, as published in The Wall Street Journal.

Prequalify for an Adjustable Mortgage

If you’d like to get a quote on an Adjustable Mortgage and/or want to know what other type of  mortgage programs you may be eligible for,  click here to get started and a member of our Team will contact you within one business day.  It’s that simple! Come on, Call The Money Man, and let us show you what makes us different.

 


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