ADJUSTABLE RATE MORTGAGES
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What is an Adjustable Rate Mortgage
An Adjustable Rate Mortgage (ARM) is a type of home loan with interest rates that can change over time, making them appealing to some borrowers due to their lower initial rates compared to fixed-rate mortgages. ARM’s are tied to an index, like the prime rate, so the interest rate can increase or decrease depending on the index’s fluctuations, leading to either lower or higher monthly payments. Most ARM’s have a fixed rate for the first five to ten years before the rate begins to adjust. Borrowers should carefully consider the terms of their ARM and be prepared for potentially higher payments in the future. ARM’s offer flexibility, but it’s important to weigh the risks and benefits before deciding if an Adjustable Rate Mortgage is the right choice.
Adjustable Rate Mortgage Overview
A mortgage rate refers to the interest rate charged on your mortgage loan. These rates fluctuate daily and are determined by changes in the market. Adjustable-rate mortgages (ARMs) are home loans with interest rates that can change over time, making them an attractive option for some borrowers due to their lower initial rates compared to fixed-rate mortgages. ARM’s are tied to an index, such as the prime rate or LIBOR, so the interest rate can either increase or decrease depending on the index’s fluctuations, leading to either lower or higher monthly payments.
Most ARM’s have a fixed rate for the first few years, typically five or ten, before the rate begins to adjust. After the initial period, the rate can change periodically, such as once a year, based on the index plus a margin, which is determined by the lender. For example, if the index is 3% and the margin is 2%, the borrower would pay an interest rate of 5%.
One of the primary benefits of ARM’s is the lower initial rate, which can make monthly payments more affordable. However, the possibility of higher payments in the future is a significant risk that borrowers must consider. ARM’s are also more complex than fixed-rate mortgages, and borrowers must understand the terms of their loan to avoid surprises later on. ARM’s can be a good choice for borrowers who plan to sell or refinance their home before the rate starts to adjust, but it’s important to weigh the risks and benefits carefully before choosing an ARM over a fixed-rate mortgage.
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How to Qualify for an ADJUSTABLE Rate Mortgage
Pre-approval is the first and most important step towards acquiring your Adjustable Rate Mortgage. Whether you’re a first-time home buyer or seeking to refinance your current home, getting pre-approved helps narrow your focus to properties that fit your budget, establish credibility with sellers, and expedites both the loan funding and closing process.
Requirements for First-Time Home Buyers:
- Good credit score: A good credit score is essential for any mortgage, including adjustable rate mortgages. First time home buyers need a credit score of at least 620 to qualify for an ARM, but a score of 700 or higher is ideal.
- Steady income: Lenders need to see a steady income to approve an adjustable rate mortgage. First time home buyers must have a stable job with a regular income that is sufficient to cover the mortgage payments.
- Adequate down payment: While the down payment requirements for an ARM are generally lower than those for a fixed-rate mortgage, first time home buyers still need to provide an adequate down payment. The down payment can range from 3% to 20% of the home’s purchase price, depending on the lender and the borrower’s financial situation.
- Low debt-to-income ratio: Lenders will look at a borrower’s debt-to-income ratio (DTI) to determine their ability to make mortgage payments. First time home buyers need a DTI ratio of 43% or lower to be approved for an ARM.
- Ability to cover future payments: First time home buyers need to be able to cover the future mortgage payments that come with an adjustable rate mortgage. Borrowers should be aware that the interest rate can change over time, leading to higher monthly payments in the future.
- Reserves: Lenders may require first time home buyers to have reserves, which are funds that can be used to cover mortgage payments in case of emergency. The amount of reserves required varies depending on the lender and the borrower’s financial situation.
Overall, first time home buyers need a good credit score, steady income, adequate down payment, low debt-to-income ratio, ability to cover future payments, and reserves to be approved for an adjustable rate mortgage. It’s important to compare different loan options before making a final decision on the type of mortgage to choose.
Requirements for Refinancing to an Adjustable Rate Mortgage:
- Good credit score: Similar to a first-time homebuyer, you will need a good credit score to qualify for an ARM. This score typically ranges from 620 to 700 or higher, depending on the lender and the borrower’s financial situation.
- Equity in the home: When refinancing into an ARM, you must have equity in your home. This means that the value of your home should be higher than the outstanding balance of your mortgage.
- Ability to handle rate adjustments: An ARM may have a lower interest rate initially, but it can adjust over time, resulting in higher payments. Before refinancing, make sure you can handle rate adjustments.
- Adjustable Rate vs. Fixed Rate comparison: Compare the interest rates and terms of both adjustable and fixed rate mortgages to see which option best fits your financial goals.
- Proof of income and employment: Lenders will need to see proof of your income and employment to ensure you can afford the mortgage payments. You should be prepared to provide documentation, such as pay stubs and tax returns.
- Refinancing costs: Refinancing into an ARM may involve closing costs, such as application fees, appraisal fees, and attorney fees. Make sure you are aware of these costs before refinancing.
Overall, refinancing into an adjustable rate mortgage requires a good credit score, equity in the home, ability to handle rate adjustments, a comparison between adjustable and fixed-rate options, proof of income and employment, and awareness of refinancing costs. Make sure to carefully consider your financial situation and goals before making a decision to refinance.
TYPES OF Adjustable Rate Mortgages
TRADITIONAL ADJUSTABLE-RATE MORTGAGES
A Traditional Adjustable-Rate Mortgage has an adjustable interest rate that changes periodically based on a specified index, such as the LIBOR or Treasury rates. The rate may change annually, semi-annually, or monthly. This type of Adjustable-Rate Mortgage may be suitable for borrowers who plan to sell or refinance before the rate adjusts.
HYBRID ADJUSTABLE-RATE MORTGAGES (HYBRID ARMS)
A Hybrid Adjustable-Rate Mortgage is a type of Adjustable-Rate Mortgage that has an initial fixed-rate period, typically ranging from 3 to 10 years, before adjusting to a variable rate. This type of Adjustable-Rate Mortgage may be a good option for borrowers who plan to sell or refinance their home before the adjustable-rate period begins.
Interest-Only Adjustable-Rate Mortgages
With an Interest-only Adjustable-Rate Mortgage, the borrower only pays the interest on the mortgage for a set period, typically 5 to 10 years, before beginning to pay down the principal. This type of Adjustable-Rate Mortgage may be suitable for borrowers with irregular or variable incomes who want lower monthly payments in the early years of the mortgage.
PAYMENT-OPTION ADJUSTABLE-RATE MORTGAGES
Payment-option Adjustable-Rate Mortgages give borrowers the option to choose how much they pay each month. This can include a minimum payment, an interest-only payment, or a fully amortized payment. However, borrowers should be aware that paying less than the full payment amount can result in negative amortization and a higher loan balance over time.
OPTION ADJUSTABLE-RATE MORTGAGES
Option Adjustable Rate Mortgages offer borrowers the flexibility to choose from multiple payment options, including a fully amortizing payment, an interest-only payment, a minimum payment, or a payment based on a specific interest rate. However, borrowers should be aware that this type of Adjustable-Rate Mortgage can lead to negative amortization and a higher loan balance over time.
There are several types of Adjustable-Rate Mortgages. Borrowers should carefully consider their financial situation and goals before choosing an Adjustable-Rate Mortgage, as each type has its own benefits and risks. It’s important to compare different loan options to find the best fit for your needs. Contact one of PRMG’s home mortgage experts today! We’ve been serving customers just like you for over 22 years. Your mortgage expert’s guidance can help you make an informed decision and secure your Adjustable-Rate Mortgage.
Pros of securing an Adjustable Rate Mortgage
- Lower Initial Interest Rates: One of the main benefits of Adjustable Rate Mortgages (ARMs) is that they typically offer lower initial interest rates than fixed-rate mortgages. This can make homeownership more affordable, especially for first-time homebuyers who may have limited funds available for a down payment.
- Potential for Savings: If interest rates decrease, borrowers with ARM’s may see their monthly payments decrease as well, potentially leading to long-term savings on their mortgage.
- Flexibility: ARM’s offer borrowers more flexibility in terms of how long they plan to keep the home or their mortgage, as well as their financial situation. For example, borrowers who plan to sell or refinance before the adjustable rate period begins may find ARM’s appealing, as they can take advantage of the lower initial interest rate without worrying about future rate increases.
- Higher Borrowing Power: Because ARM’s offer lower initial interest rates, borrowers may be able to qualify for a larger loan amount than they would with a fixed-rate mortgage.
- Short-Term Affordability: For borrowers who expect their income to increase over time, an ARM may offer short-term affordability by allowing them to make lower monthly payments in the beginning, with the expectation that they can make larger payments in the future when their income increases.
Cons of securing an Adjustable Rate Mortgage
- Risk of Payment Shock: One of the biggest drawbacks of Adjustable Rate Mortgages (ARM’s) is that the interest rate can increase significantly over time, leading to a corresponding increase in the borrower’s monthly payments. This can result in payment shock, where the borrower suddenly finds themselves unable to afford the higher payments.
- Uncertainty: Because the interest rate on an ARM can change periodically, borrowers with ARM’s may experience uncertainty about their future payments, making budgeting and financial planning more difficult.
- Potential for Negative Amortization: Some ARM’s, particularly those with payment-option features, may allow for negative amortization, where the borrower’s monthly payment is less than the interest due on the loan, leading to an increase in the loan balance over time.
- Difficulty in Refinancing: If interest rates rise and the borrower’s monthly payment becomes unaffordable, they may have difficulty refinancing the loan if they owe more than the home is worth. This can result in the borrower being unable to sell or refinance the property, leading to potential financial difficulty.
- Higher Overall Cost: While ARM’s may offer lower initial interest rates than fixed-rate mortgages, if the interest rate increases significantly over time, the borrower may end up paying more in interest over the life of the loan.
- Limited Predictability: Unlike fixed-rate mortgages, ARM’s do not offer borrowers predictability in terms of their future payments. This can make it difficult for borrowers to plan for the future and may lead to financial stress.
FAQS ABOUT Adjustable Rate Mortgages
What is an Adjustable-Rate Mortgage (ARM)?
An Adjustable-Rate Mortgage is a type of mortgage where the interest rate can change periodically over the life of the loan.
How does an Adjustable-Rate Mortgage work?
With an ARM, the interest rate is typically fixed for an initial period of time (e.g., 5 years), and then adjusts periodically based on a specified index (e.g., the LIBOR rate) and a margin determined by the lender.
What is the difference between an Adjustable-Rate Mortgage and a fixed-rate mortgage?
The main difference between an ARM and a fixed-rate mortgage is that with an ARM, the interest rate can change over time, while with a fixed-rate mortgage, the interest rate is fixed for the life of the loan.
What are the drawbacks of an Adjustable-Rate Mortgage?
Some potential drawbacks of an ARM include the risk of payment shock if interest rates increase significantly, uncertainty about future payments, potential for negative amortization, difficulty in refinancing, higher overall cost over the life of the loan, and limited predictability.
How often can the interest rate change on an Adjustable-Rate Mortgage?
The interest rate on an ARM can typically change annually, although some loans may allow for more frequent rate changes.
How is the interest rate on an Adjustable-Rate Mortgage determined?
The interest rate on an ARM is typically based on a specified index, such as the LIBOR or the Treasury Bill rate, plus a margin determined by the lender.
Are there caps on how much the interest rate can increase or decrease on an Adjustable-Rate Mortgage?
Yes, most ARM’s have caps on how much the interest rate can increase or decrease at each adjustment period, as well as a lifetime cap on how high the interest rate can go over the life of the loan.
Who is an Adjustable-Rate Mortgage best suited for?
ARM’s may be best suited for borrowers who plan to sell or refinance the property before the adjustable-rate period begins, as well as those who expect their income to increase over time and can therefore handle potential payment increases. It’s important to carefully consider your financial situation and future plans before choosing an ARM.
SECURING YOUR 30-YEAR FIXED-RATE MORTGAGE HAS NEVER BEEN EASIER!
Whether you are a first-time homebuyer or are looking to refinance your existing mortgage, PRMG’s Home Mortgage Experts can provide you with the information and resources you need to make an informed decision about your financial future. We pride ourselves on our commitment to customer service and will work tirelessly to ensure that you receive the best possible experience.