When you are given the chance to select what kind of mortgage loan you would like to acquire, how do you make that choice? Is it simply a matter of finding the loan with the lowest interest rate? Or is it more than that? If you are given a choice between a fixed rate mortgage loan and an adjustable rate mortgage loan, which one should you choose? While there may never be a black and white answer to this problem, here are some facts you need to know about an adjustable rate mortgage loan.
An adjustable rate mortgage loan (ARM) is a type of loan wherein the borrower’s payments vary from time to time, depending on certain points of reference called indices. Basically, this feature allows flexibility on the borrower’s side but it may work against him if the indices suggest an increase in the interest rate and periodic payments on the mortgage. Among the most commonly used indices are the rates of a 1 year constant maturity Treasury securities. 3 year and 5 year treasury securities may also be used as indices.
As previously mentioned, a borrower of an ARM may experience changes in payments during the mortgage period. The question now is among all the ARM’s available for the public, which one is the best way to go. To decide on this, a lot of factors have to be taken into consideration.
Among these factors are market industry indexes, payment options, discounts, caps on rates and payments, margins, negative amortization, and recalculating a borrower’s loan. The main issue with adjustable rate mortgage loans is the win-loss game that each index change may bring about. Compared to a fixed rate mortgage, a borrower’s payments on an ARM may be very low for a few months, go up suddenly and stay high for a few months more, and then begin to climb back down again. A fixed rate mortgage, as the term suggests, does not pose this changing feature.
If the interest rates remain relatively low, a borrower is lucky enough to have an ARM. Against this advantage, however, he or she has to weigh certain disadvantages than may happen just as likely. The borrower has to bear the risk of possibly higher monthly payment in the future. This is a basic rule in risk. A trade off thus exists. The borrower may have lower initial rate with an ARM, but he acquires risk along the long run.
The initial rate may be implemented on a wide range of time. Some initial rates are implemented only for 1 month. Others are implemented for the 1st year of the loan, still others 3 or 5 years. A borrower has to be prepared to hand out very varying payments per period, even if interest rates remain relatively stable. The final decision on whether to choose a fixed or adjustable rate mortgage loan depends on the borrower. What is important is that he makes an informed decision that in some way minimizes risk on his part.