Adjustable rate mortgages (ARMs) can be useful. During the mortgage crisis, this variable interest rate plan was connected to a lot of terrible products such as balloon loans, negative amortization loans, and other predatory tools. This blog will inform you as to how adjustable rate mortgages really work.
How ARMs Work
First, you need to know how adjustable rate mortgages adjust. I’ll refer to the more popular products which are Hybrid ARMs. These loans are at a fixed rate for the first 3, 5, 7, 10, etc. years. Depending on how the market is performing, these rates will typically be lower than a fixed rate product. The most common option is a 5-1 ARM. This means the loan is fixed for the first five (5) years then adjusts once (1) per year after the fixed period has completed. The full amortization is 30 years.
Your interest rate will increase or decrease during the adjustable period. This is based on the market. If rates are high, your rate will increase. If rates are low, your rate will lower. Your product will be associated with a series of numbers typically presented like (5/1/5). These are the caps of increase per year. The first 5 means that your rate can only increase 5% during the first increase (year 6 for a 5-1 ARM). That 1 means your rate can only increase 1% per year each year following (years 7-30). That final 5 means your rate cannot increase more than 5% from your initial fixed rate during the life of the mortgage. This keeps everything from getting out of control.
One cool thing to note is that when your rate does fluctuate that once per year, your new payment is based on the remaining balance. This means your interest rate could increase but your payment could still decrease based on additional payments you’ve made or just where you are in the amortization schedule.
Every situation is different. Most people do not like the idea of adjustable rate mortgages because you need to update your budget each year. There is a risk of payment increase. There is definitely a comfort threshold that needs to be met. When we plan your next and future mortgages, we can discuss whether or not this is a viable option for you and your situation.
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