Adjustable Rate Mortgages

Adjustable Rate Mortgages (ARMs) is where payments remain fix for a period of time and then it starts to fluctuate afterwards. For example, for a "3/1" ARM, this means payments remain fix for first 3 years and adjusts every year after that. While payments are INITIALLY generally lower than a 30 year fix loan, you have to be aware after the initial period, your interest rate will increase over time.

On all ARMS, there is cap limit on how much interest rate may increase or decrease. There are generally 2 types of cap limit. One is called "Adjustment Cap" and the other is called "Lifetime cap." Adjustment Cap sets the limit on how much the interest rate can increase or decrease. For example, if adjustment cap is set at 2% and your current interest rate is 6%, that means your new interest rate can not go above 8% or below 4%. For lifetime cap, it sets the maximum interest rate you can ever pay in any given year over your start rate. For example, a 6% lifetime cap means that your interest rate can go up 6% over your start rate. If your start rate was 6%, that means the lender can charge you 12% interest!

Anyway, interest rate on ARMS are base on how the securities market is doing. Mortgage interest rates are tied to current market conditions and a good measure of market conditions are yields on treasury securities. The index is normally the weekly average yield on a 1, 3 or 5 Year Treasury Security 30 or 45 days prior to your adjustment date. Keep in mind, a 1 Year Treasury yield is lower than a 5 Year Treasury yield.To this index, the lender will add a margin of X% determined solely by the lender. A lender could add a margin of 2.25%, 2.5% up to or greater than 3% to the index to determine your new rate. When shopping for an ARM you want to look for the lowest term treasury security index with the lowest margin.

The Caps, Margin and Index play an important deciding factor when shopping for an ARM. For example; you have been quoted the following rates and terms on a 3/1 ARM both with a 1 Year Treasury Security index:

Loan #1 - Rate 6.00%: Caps are 2% per adjustment, 6% lifetime with a Margin of
2.75%

Loan #2 - Rate 6.125%: Caps are 2% per adjustment, 5% lifetime with a
Margin of 2.50%

On the surface, loan #1 looks like the better loan since the interest rate is .125% lower than loan #2 and that holds true if you plan on moving or refinancing your loan at the end of the three years. But if there is a chance you will keep the loan beyond 3 years, loan #2 is probably the better way to go because 1) when loan #2 adjusts, the rate will always be .25% below loan #1 (unless it adjusts the full 2%) and 2) the lifetime cap is a full 1% lower than loan #1.

Is ARM right for you? Well, how long do you plan to live in the home? Are you going to refinance before the interest rate adjustment? Are you able to afford the highest interest payment?

ARM are not for everyone. If you can't afford the highest interest payment and/or you need to refinance, then a 30 year fix rate loan is the way to go.

Balloon Mortgage

What is a balloon mortgage? A balloon mortgage is a fixed-rate loan where principal and interest are calculated over a 30 year period. The main difference between a 30 year fix and a balloon mortgage is the number of years you have to pay. For example, for a 7 year balloon, while payments are similar to a 30 year fix loan, by the end of the 7th year you have to PAY OFF THE REMAINING BALANCE.

This type of mortgage is good for people who plan to sell the home before the term expires or they plan to refinance. Just remember, when you refinance, there are closing costs and other fees involved.

Interest Only Mortgage

As the name implies, interest only mortgage is where you only pay the interest for a temporary time, which is usually 5 or 10 years. Homeowners may pay more than the minimum balance to lower the principal balance. Remember, principal is the amount of money you owe to the lender. Interest is what the lender charges you for the loan.

If homeowners only pay the interest, the balance of the loan remains unchanged. That's because none of your payment is going toward the principal. When the interest only term expires, your monthly payment will increase to include the principal. For example, for a $100,000 loan at 6.25%, the required monthly payment is $520.83 for the first 5 or 10 years. Without the interest only option, the required monthly payment will be $615.72.

Who buys interest-only mortgage? People who likes the flexibility of paying the principal. People who wants to buy a more expensive home. People who expect their income to rise over the next few years. People who need to invest the difference (Interest minus the principal) in hope that their investments' rate of return will be greater than the interest being charged on their mortgage. If you don't meet any of these reasons, this type of mortgage is definetly not for you.

Why am I against this type of mortgage? For one, you are not paying any principal into your home. Therefore, you are not building any equity into your home. Equity is included when determining the value of your home from year to year. In the long run, you may need to use the equity to fix up your home or for emergency uses. If you don't have any equity, you don't have this option. Second, when your interest-term expires, homeowners may experience a huge payment shock because their monthly payment just increased. Third, this is a high risk loan to the lender. Because of this high risk, the lender will charge more fees than a traditional loan that includes principal and interest in the payment.

To learn more about what the US Government has to say about Interest-only mortgage, go here: http://www.federalreserve.gov/pubs/mortgage_interestonly/