If you are considering an Adjustable Rate Mortgage (ARM) to purchase your home or to refinance your existing loan, there are a number of things you need to know to avoid overpaying for the financing. When used correctly, Adjustable Rate Mortgages are an excellent financial tool that can save you money. Here are several tips to help you decide if an ARM loan is right for you.
Adjustable Rate Mortgages are an attractive loan option for many homeowners because of their lower introductory interest rates and payment options. These loans carry more risk than a fixed interest rate loan; they are often abused by homeowners that do not understand them. When abused, Adjustable Rate Mortgages have the potential to cost you thousands of dollars. Improper use of and ARM loan could even cost your home to mortgage foreclosure.
Before you decide to take out an Adjustable Rate Mortgage it is important to understand how your interest rate is set. Every Adjustable Rate Mortgage is tied to some financial index like the prime rate. When the mortgage lender adjusts or “resets” the interest rate they will use the rate from this index plus their own markup. When the index rises and falls according to your loan’s anniversary date, your mortgage payment amount will rise and fall with it. Most Adjustable Rate Mortgage loans come with a very low introductory interest rate. This low rate is only valid for the introductory period and is used to attract borrowers. At the end of the introductory period the lender will adjust your interest rate to the loan’s actual rate and the payment amount will increase significantly.
The frequency of lender adjustments varies from one ARM loan to the next. These loans are designated by two numbers. The first number the length of the introductory period, followed by the frequency of lender adjustment. An example of this designation is a 5/1 Adjustable Rate Mortgage. This “5/1” means the introductory interest rate is good for the first five years and after that the lender will adjust or “reset” the interest rate every year based on the index your loan.
Due to the inheritably risky nature of Adjustable Rate Mortgages, there is protection build into these loans when they are structured properly. Caps protect borrowers from excessive swings in the interest rate and payment amounts. Caps come in two varieties: there are interest rate caps that protect from excessive changes in the adjustable interest rate. Payment caps work the same way but protect from excessive changes in the monthly payment amount. It is important to structure your Adjustable Rate Mortgage to include both interest rate and payment caps. Loans that are not structured properly often experience negative amortization because the cap prevents the payment amount from adjusting properly to cover all the interest due in any given month.
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Louie Latour specializes in showing homeowners how to avoid costly mortgage mistakes and predatory lenders. For a free copy of "Mortgage Refinancing - What You Need to Know," which teaches strategies to find the best mortgage and save thousands of dollars in the process, visit Refiadvisor.com.
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