What is an ARM Mortgage?

Introduction

ARM mortgage is an acronym for adjustable rate mortgage. The interest rate of ARM mortgage is connected to an economic index. The interest rate and the payment installments are adjusted with the fluctuations in the index. The index is a standard lenders use to measure changes in interest rates. The index measures the activity of treasure securities in the one year, three year and five year tenures.

Benefits

ARM mortgage interest rates are lower than a fixed mortgage, where interest rates remain the same throughout the loan period. Lower interest rate translates into lower repayment, so you would benefit immensely if you are applying for a larger loan. However this might not apply in a situation where you plan to resell the property soon. In case your income is going to increase, you can safely apply for an ARM mortgage- the higher income will take care of any increase in interest rates.

Factors to Consider

The lender’s margin is an important factor to consider while applying for an ARM mortgage. The lender’s margin includes their cost of business and their targeted profit on the loan. You will also need to consider the adjustment period, which is how often the adjustments are made. For instance, if you are applying for an ARM mortgage with annual adjustments, interest rates can change every year.

ARM mortgages come with the provision to be converted into fixed rate mortgages in future. However chances are that the cost of conversion will equal the savings you have made by going with the ARM mortgage so far.

It is also possible to set interest rate caps for your ARM mortgage. There are both overall caps and periodic caps. Overall cap, which became legalized in 1987, specifies how far the interest rate can increase during the whole loan tenure. Periodic caps set the limit for interest rate increase from one adjustment period to the next. Another method called payment cap specifies how much the monthly payment can increase with each adjustment.

Negative Amortization

Negative amortization happens when your payment installments do not meet the interest amount. In this case the unpaid amount is added to the debt capital and goes to generate more interest. This is quite a dreadful situation as your payments continue and you end up owing more than what you did when you took the loan. Therefore it is important to consider all these eventualities before you sign the ARM contract. Remember to get as many quotes as possible and take expert advice.