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Adjustable Rate Mortgages-Can I Control The Cost? Staff - Mortgage Lenders Plus.com

When adjustable rate mortgages (ARMs) were first introduced, the entire notion had great shock value for the naturally conservative banking industry. Who would want a thirty year loan with interest rates that couldn’t be predicted for twenty nine of those years? A loan where the current mortgage interest rate wasn’t the thirty-year interest rate was an alien and frightening notion.

This year, thirty seven percent of all home loan interest rates will be based on an adjustable rate formula. These loans have become a fixture in the domestic housing market and have bred dozens of mutations including the interest only ARM and the option ARM. The fact is that many people who wish to own homes cannot afford a twenty percent down payment, which is often the benchmark for obtaining a fixed rate mortgage.

That does not mean that everyone who opts for an ARM will do so with no understanding of what future home loan interest rates will be for them. There are a number of adjustable rate mortgages that can be construed as nearly competitive with fixed-rate loans, depending on the borrower’s circumstances and the nature of the ARM.

Since the initial rate of most ARMs is based on the current mortgage interest rate, you can get into an ARM at an extremely low initial rate. If you’re only going to be in the house for six or seven years, an ARM with a seven year grace period (called a 7/1) might be a great deal. However if you intend to extricate yourself from any ARM prior to the loan’s completion, make sure it has no prepayment penalty written into the fine print.

Once the grace period for an ARM has passed, it is readjusted annually based on the combination of an index – some money market figure – and a margin, the number of percentage points that is added to the index in order to determine your home loan interest rate for the year.

Some indexes are based on averages – such as the twelve month average interest rate on a one-year Treasury bill. Because of the way the U.S. monetary system works, many times the current mortgage interest rate closely matches the movement in Treasury rates. An average index is going to be less volatile than the other option, known as a spot index. This figure is taken from a money market rate such as the London Interbank Offering Rate (LIBOR) and your ARM index will be whatever the LIBOR rate is on the day your Arm is set to adjust for the following year.

These spot indexes are inherently more risky than averages, and so will carry a lower margin than ARMs that use averages. If you want to be cautious, select an ARM with an averaged index. When you are going through the process of obtaining the loan, lock in at the current mortgage interest rate for your loan so that you don’t begin your mortgage with an unpleasant surprise.

Adjustable rate mortgages do carry a degree of unpredictability, but you can keep the maximum change in your home loan interest rate within certain parameters. The best advice for controlling the change in your ARM is to stay away from interest only ARMs and option ARMs. If you’re going to buy a house, buy one that you can afford to pay on the loan’s principal as well as interest.