Adjustable Rate Mortgage - ARM Loans
Adjustable rate mortgage (ARM) are type of loans in which interest rate is not fixed for the life of loan. In fixed-rate mortgage the interest rate stays the same during the whole period of loan with ARM the interest rate changes often usually The interest rate varies based on one or many indexes. Each lender uses different indexes for adjustable mortgage rate. The ARM rate may start from lower but can go very high sometimes alot even if the interest rate don't go up your mortgage rate may jump. Many lenders increase decrease rate by indexes they are tied to like treasury notes and treasury bills, federal housing national average mortgage rate, LIBOR or U.S. primie rate but there is always a life time cap and they can increase or decrease the amount as long as they are inside the maximum and minimum rate cap.
Your mortgage monthly payment can rise sharply with every rate adjustment, these mortgages have adjustment periods of every six months to one year and your payment can keep going up.
Your payment may never go down even if the interest rate drops, many ARM loans have a interest rate caps this cap may not let your rate fall even if the index they are tied to falls.
Many ARM loans are with negative amortization that you might end up owing more money then what you borrowed, even if you make all your payments on time. This happens because the monthly payment you agreed may not be enough to cover the interest due, you may have payment cap not the interest cap. This cap limits the increase in your monthly payment and adds the due interest in your balance with negatize amorization you will end up paying more than you borrowed many ARM lenders have total amount of cap and once you hit that cap amount they will set your payment to pay off the whole loan over the remaining period.
Your ARM loan may be interest only loan even if you keep making payments on regular basis your loan balance will always stay the same even if the payment jumps up and you make monthly mortgage payment on time your principle balance will never go down.
ARM Pre-payment penalty may not let you pay off your mortgage with out heavy fee and penalties.
Types of ARM ("Adjustable Rate Mortgage")
Hybrid ARM Loans
These loans are mix of fixed-rate mortgage and adjustable-rate mortgage. The interest rate is fixed for the first few years like you may have seen lot of advertisments of 3/1 and 5/1 ARMs loans, these means that first part of period loan is fixed rate and then it will adjust every year or every six months. A 3/1 ARM means your rate will be fixed for first 3 years and then it will adjust annually.
Interest Only ARMs
The interest only ARM mortgage allows you to pay only the interest for a number of years which can be from 1 to 5 years, this means that your payment will be smaller in the start of loan and after that your monthly payment will increase even if the interest rate does not change your payment will go up because you will start making payment towards orignal balance.
ARMs with Payment Option
These loans allow you to make interest only payment but allows you to make payment towards principle balance of loan. These loans are very famous and a can work like fixed rate mortgage where you make payment on interest plus on mortgage balance, you can make payment towards interest only and skip the payment towards mortgage, some lenders even have option of paying a set minimum payment which might not even cover the interest you owe on your mortgage. If you choose option like this one then your mortgage balance may start increasing like negative amortization.
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