Mortgage Products: The Adjustable RateMortgage

You’ve found the home of your dreams, you’re pre-qualifiedfor a loan, and everything looks absolutely rosy. At first. As you begin to traverse the actual home appraisal, the loanamortization, your down payment, and all the dots that must be connected inorder to make the dream a reality, you suddenly realize that you may not beable to afford a payment on the Fixed Rate Mortgage plan. What other options are available? Well, there’s the Adjustable Rate Mortgagethat is a close first cousin to the Fixed Rate mortgage, just a littleriskier. What advantages does theAdjustable Rate Mortgage option offer, and what are they drawbacks, if any? This article examines the advantages anddisadvantages, if any, of the Adjustable Rate Mortgage.

The Adjustable Rate Mortgage, or ARM,is a more affordable option for homeowners who have a fairly tight monthlybudget, and who have a need for bigger house, lower payment. The typical ARMcustomer wishes to build equity in their home; however they need the lowestmonthly payment possible, for a certain number of years. The homeowner this program most benefits isthe individual who expects income increases to occur within a few short years,but also has an expanding family with a need for space. 

An ARM works in this way: when you set up yourmortgage on an ARM, the interestrate you have will only be set for a very short period of time, normally only6,9, or 12 months. At the end of thatperiod, the interest rate will be re-evaluated, and if the rates have increasedbased on the prime, your interest rate will also increase; once again, for ashort, set period of time. The benefitderived from this type of loan, during today’s economy, is that the interestrates are at an all time low. Thatequates to big savings for current home buyers, and homeowners who refinance.

The disadvantage to this type of loan occurs when interest rates begin torise. As the rate rises for the lendinginstitution, it also rises for you, the homeowner. Today, there are spin-offs on the ARM base product, that allow homeowners to operateunder an ARM for a specifiednumber of years, and then the loan converts to a fixed rate mortgage. There are also the ARMs that offer aninterest only option for a specific number of years, then it converts to abasic ARM for a specified numberof years, and then you have the option to convert the ARMto an FRM. The home mortgage productmarket can be very confusing, and quite frustrating if you don’t take the timeto fully research and understand your mortgage options.

Another great benefit to the ARM, wheninterest rates are low, is that it allows you to build equity faster than witha standard fixed rate mortgage. But ifinterest rates begin to rise, quickly, your opportunity for building equityquickly, is greatly diminished, because more of the payment is directed to theinterest on the loan. If you fall intothe category of the typical homeowner, ARMs aren’t as attractive as the fixedrate mortgage; but let’s face it the typical homeowner category seems to beshrinking.

There are so many options with the ARM basicmodel, that the ARM option loanshave become more popular than just the basic ARM.The 3,5,7 and 10 year ARMs that offer interest only options for a set period oftime, or that offer 1% interest for the first month, then there are the ARMsthat offer interest only for 3,5,7, or 10 years, then a standard ARM is established, or a FRM is established. 

The mortgage industry has made available so many mortgage choices, that it’s oftenvery difficult for the average consumer to consider all the options and makethe most wise choice, simply because you need a spreadsheet and calculator justto compare the options, never mind making a decision about the best options.

All in all, if you are buying a home, and your income level is expected to increase overthe next 10 years, or your expenses are going to drastically decrease, youwould probably benefit from the standard ARMthat converts to a FRM. All the othercomplicated options still simply do not benefit the average homeownertoday. Now, if you don’t happen to beaverage, and you have a financial advisor that can work with you closely, I’drecommend that you consider all those other options, but only with theassistance of a trained financial analyst. After all, your home is a purchase you definitely do not want put atrisk.