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
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
Preapproval 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 preapproved 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:
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.
Good Credit Score:
A good credit score is essential for an adjustable rate mortgage. First time home buyers need a credit score at the “good” to “excellent” level to qualify for an ARM.
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 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 amount ranges but is based on a percentage of the home’s purchase price, and is dependent on the borrower’s financial situation.
Low D.T.I. 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 within the Lender’s range to be approved for an ARM.
Preparedness:
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.
Cash 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.
Requirements for Refinancing to an Adjustable Rate Mortgage:
Overall, refinancing into an adjustable rate mortgage requires a good credit score, equity in the home, ability to handle rate adjustments, 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.
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 “good” to “excellent” and depends on the borrower’s financial situation.
Home Equity:
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.
Financial Stability:
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.
Documentation:
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.
Fees:
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.
TYPES OF Adjustable Rate Mortgages
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.
Adjustable-Rate Interest Only Loans
With adjustable-rate interest only loans, borrowers enjoy an initial fixed-rate period, typically 5 to 10 years, followed by an adjustable interest rate. During the interest-only period, borrowers pay only the interest portion, allowing for lower initial payments.
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 professionals today! We’ve been serving customers just like you for over 22 years. Your mortgage professionals guidance can help you make an informed decision and secure your Adjustable-Rate Mortgage.
Pros of securing an Adjustable Rate Mortgage
Lower Intitial Interest
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 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.
Qualify for Larger Loans:
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 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.
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.
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 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.
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