5 Things Houston first time home buyers Should know About Adjustable Rate Mortgage (ARM)
As a first time home buyer, you may have already began speaking with your mortgage company about getting a fixed mortgage loan, however, if you are purchasing a home and plan to stay in the home for only 5 years, getting a higher fixed rate mortgage may not be in your best interest if you can qualify for a lower interest adjustable rate mortgage loan (ARM), that could potentially save you thousands of dollars in interest payment.
What are adjustable rate mortgage loans? They are mortgage loans in which the interest rate will adjust periodically throughout the life of the loan after the initial period ends. This of course will cause your monthly mortgage payment to go up or down. However, for the first few years, your rate will be fixed, with the adjustments taking place, only after the initial period ends.
How do They Work? Let's say, you are applying for a 7/1 ARM, your rate will stay the same for the first 7 years before adjusting. This rate is usually lower than market condition dictates. Once the initial period ends in 7 years, you rate will adjust based on the current market rate. To avoid surprise, always take the time to read the fine print so you know when the rate will adjust. ARM rates usually adjust yearly, with the exceptions of ARMs that are structured with 6-month adjustment periods, such as a 7/6 ARM.
Be aware - You should know that you may be able to qualify for a larger mortgage amount because of the lower initial payments. In addition to the usually lower rates, rates and payments can rise significantly over the life of the loan and some annual caps may not apply to the initial adjustment. Below are the basic components of every Adjustable Rate Mortgage (ARM)
1. Index
2. Margin
3. Adjustment Period
4. Interest rate cap
5. Initial interest rate
The Index
An ARM’s interest rate is tied to one of many economic indices, some examples of which are the 1-year constant maturity Treasury security, the Cost of Funds Index, or the London Interbank Offered Rate. Different indices move at different rates so you will need to know the characteristics of the index used for your ARM.
The Margin
The interest rate for your ARM will be calculated by adding a margin to the rate from the index. The margin is basically the markup charged by the lender that allows them to make a profit off of your loan. The margin of your loan usually does not fluctuate.
The Adjustment Period
The Adjustment Period controls when and how often your interest rate changes. Once the adjustment occurs at the end of each year, your monthly mortgage payment will be recalculated to reflect the change.
The Interest Rate Cap
Interest rate caps are built into the loan to protect you, the borrower from drastic interest rate fluctuations. The caps limit how much the interest rate or monthly payment can change at the end of each adjustment period. An ARM can also have a cap for the life of the loan. For example, during the life of a loan, the interest rate may only be increased by 4%.
The Initial Interest Rate
The Initial Interest Rate is the interest rate that you start with at the beginning of your loan period. The length of time your loan stays at this rate is built into the loan.
Buying a home involve many steps, and choosing the best financial product that is right for you and will save you money in the process is a part of every home buyer's goal. We want you to be happy with your entire home buying experience, so we provide information that we hope you continue to find useful. As always, thank you so much for stopping by. Until next time...Diana
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