Tracy Suttles Helps Understand Adjustable Rate Mortgages
July 8, 2017
The following is a guest post from Houston, Texas real estate developer and entrepreneur Tracy Suttles.
There are many reasons to consider an adjustable rate mortgage (ARM). With fixed mortgage interest rates rising, ARMs are becoming popular again. Some consumers may be advised that they need an ARM product in order to qualify for the mortgage that they are requesting. Other consumers may want to take advantage of a lower interest rate mortgage on a home that they do not plan on owning for long. Whatever your reasons may be, there are many ARM products and they can be confusing. Hopefully, the following will help clear up some common questions regarding various loan products.
GENERAL ARM CHARACTERISTICS
An ARM has an initial interest rate that is substantially lower than current fixed mortgage interest rates. This is called the start rate or teaser rate. How long the start rate is in effect varies from product to product. The interest rate is determined by an index. The index used varies by product also.
An index is a measurement tool that reflects the cost of money. Interest rates are set by lenders who determine the cost of money using an index. For instance if the index raises, fixed mortgage interest rates rise. In the same way, when the mortgage is set to adjust, it adjusts based on the current index. The best indexes are ones that don’t move too often. There are many different indexes and different ARM programs use different ones.
There are protection clauses in ARM products. Each product has a predetermined amount that the interest rate can change per adjustment. This is called the adjustment cap. It protects the consumer from going from a 4% interest rate to a 10% interest rate on one adjustment. Each product has a predetermined amount that the interest rate can change over the life of the loan also. This is called a lifetime cap. It protects the consumer from going beyond a reasonable amount above where they started. The caps make the interest rate adjustments more of a gradual process and protect consumers from giant leaps, which could lead to financial difficulties.
The margin is also an important aspect of an ARM. The margin is the number that is added to the index to determine the new interest rate at adjustment time. The lower this number, the lower the change to the interest rate at adjustment time. Some loan programs allow the option to pay discount points to buy down the interest rate. In the case of an ARM, it may be in your best interest to buy down the margin instead. The initial interest rate will change shortly, so why pay for it to start lower? Instead, you can get a lower margin which will affect every single adjustment to your mortgage.