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Understanding the Features of Adjustable Rate Mortgages

Category: Finance

An ARM (adjustable rate mortgage) is one of the common options for homebuyers. The loan initially has a fixed interest rate for a predetermined period. After the lapse of this period, the interest rate changes based on the current market index.

There are three main types of ARMs you can get from mortgage brokers in Tempe, and these include payment-only, interest-only, and hybrid ARMs. Regardless of your ARM choice, there are standard features shared by all ARMs.

Here are some of these features:

Index

All ARMs are linked to a particular index set by key market players. This index is the determinant on how your interest changes after the expiry of its initial phase. If the index rises, then your monthly mortgage payments also increase and vice versa.

Most ARMs are connected to the LIBOR (London interbank offered rate), maturity yield on one-year Treasury bill, and COFI (11th district cost of funds index) indexes.

Margin

Lenders add a set percentage to the set index rates called the loan margin. This margin differs among lenders but remains constant throughout the lifetime of your mortgage. You will know the margin your lender will apply when you take out the mortgage.

Caps

For ARMs, the sky isn’t the limit. There are certain limits to how high your interest rates may rise. There are three forms of caps. Periodic caps limit how high your interest can increase annually while lifetime caps limit the interest rise over your entire loan period.

Payment caps limit the interest rates in dollars of monthly payments and not its percentage. Lenders also disclose these caps up front.

There are many benefits of taking an ARM over other mortgages. It has lower interest rates compared to fixed-rate mortgages and offers more flexible payment plans. This allows homebuyers to purchase homes that may initially appear expensive.