Adjustable Rate Mortgages (ARMs)
Unlike fixed rate mortgages, which offer an interest rate and payment that stays the same over the life of the loan, Adjustable Rate Mortgages (ARMs) change periodically.
Lenders often charge lower initial interest rates for ARMs than for fixed-rate mortgages. This makes the ARM easier on your budget at first (compared to a fixed rate loan) and, in many cases, can actually boost your buying power. In some cases, ARMs are less expensive over a long period of time than a fixed-rate mortgage - like when interest rates remain steady or move lower.
Although there are many advantages to ARMs, it is important to weigh these against the risk that an increase in interest rates may lead to higher monthly payments in the future. It's a trade-off that you should carefully consider.
Here are some questions that should help you with your evaluation:
- Is my income likely to rise enough to cover higher mortgage payments if rates go up?
- Will I be taking on other sizable debts, such as a loan for a car or school tuition in the near future?
- How long do I plan to be in this home?
With most ARMs, the interest rate and monthly payment change annually or semi-annually. The period between one rate change and the next is called the adjustment period. So, a loan with an adjustment period of one year is called a one-year ARM, and the interest rate can change once every year.
Most lenders tie ARM interest rate changes to changes in an "index rate." These indices usually go up and down with the general movement of interest rates. If the index rate moves up, so does your mortgage rate in most circumstances, and you will probably have to make higher monthly payments. On the other hand, if the index rate goes down, your monthly payment may also go down.
Several types of ARMs come with an interest rate cap. An interest rate cap places a limit on the amount your interest rate can increase or decrease. Interest caps come in two versions:
Periodic Caps - limit the interest-rate increase and decrease from one adjustment period to the next
Lifetime Caps - limit the interest-rate increase and decrease over the life of the loan
These caps help protect borrowers from extreme increases in monthly payments. However, in some cases caps can also create unexpected results. For instance, in some cases a drop in interest rates may not always lead to a drop in monthly payments. All in all, caps should be viewed as a tool that helps regulate extreme changes in your interest rate.
Some loans may require you to pay special fees or penalties if you pay off the ARM early, while others allow you to pay the loan in full or in part without penalty whenever the rate is adjusted. At LBS Financial Credit Union, you don't incur a prepayment penalty.
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