The Pros And Cons Of Adjustable Rate Mortgage

The Pros and Cons of​ Adjustable Rate Mortgage
An adjustable rate mortgage,​ commonly referred to​ as​ an​ ARM,​ is​ a​ mortgage where the​ interest rate on​ the​ mortgage changes periodically,​ on​ a​ schedule,​ according to​ an​ index .​
The most common indexes used to​ determine the​ interest rates are:
One-year constant maturity treasury securities (CMT)
Cost of​ Funds Index (COFI)
London Interbank Offered Rate (LIBOR)
A lending institution's own costs of​ funds.
The mortgage payment that you​ pay will thusly change,​ either up or​ down,​ to​ ensure a​ steady margin for the​ lending institution.
For many people who are looking at​ mortgages,​ the​ adjustable rate mortgage can seem like a​ great idea,​ however there are many pros and cons to​ an​ adjustable rate mortgage - items that need to​ be weighed over the​ short and long term to​ decide whether an​ adjustable rate mortgage is​ right for you​ or​ not.
The Pros of​ an​ Adjustable Rate Mortgage
The initial interest rate on​ an​ adjustable rate mortgage looks great on​ paper .​
Most often,​ the​ adjustable rate mortgage inserts rate is​ much lower than a​ fixed rate mortgage,​ which also means that the​ payment is​ lower .​
As a​ borrower,​ this lower interest rate can also mean that they can qualify for a​ higher loan amount if​ the​ lender is​ willing to​ base their ability to​ pay on​ the​ initial monthly payment amount .​
It's important to​ do some research on​ the​ interest rates and see where they are sitting at​ in​ comparison to​ the​ six months to​ a​ year prior.
An adjustable rate mortgage is​ a​ good idea for people who only plan on​ staying in​ a​ house for a​ few years - from three to​ five years .​
Taking advantage of​ the​ lower interest rate that accompanies an​ adjustable rate mortgage is​ a​ good idea in​ this case .​
It means that you​ will 'pay less' for the​ home that you​ will be living in​ over the​ period of​ the​ three to​ five years,​ and gain more in​ equity in​ your home.
The Cons of​ an​ Adjustable Rate Mortgage
The biggest issue with an​ adjustable rate mortgage is​ that the​ interest rate will rise and thusly,​ so will your monthly mortgage payments .​
You have to​ decide whether the​ gamble is​ worth it​ or​ not .​
If you​ are looking at​ getting a​ raise in​ the​ next year from your job,​ then you​ may be able to​ handle an​ increase in​ your mortgage payments.
Some of​ the​ adjustable rate mortgages that are offered by lending institutions have a​ prepayment penalty,​ which you​ incur if​ you​ pay the​ mortgage off early .​
By having this prepayment penalty,​ you​ could be opening yourself up to​ a​ lot of​ strife - having a​ prepayment penalty on​ your mortgage contract is​ never a​ good idea because you​ simply just do not know what the​ future will bring.
You must also consider the​ payment cap .​
a​ payment cap sounds great - your mortgage payment can not go above x amount of​ dollars,​ however,​ that doesn't mean that the​ interest charge is​ capped .​
If the​ interest rate raises high enough that you​ go over your payment cap,​ the​ lender adds the​ interest to​ your mortgage debt,​ which then finds you​ in​ the​ position of​ paying interest on​ the​ interest .​
This can translate to​ you​ paying much more for your home than you​ did when you​ bought it​ - this is​ called negative amortization .​
Many lenders have a​ cap on​ negative amortization that you​ can have,​ and if​ you​ reach that point,​ your payment cap goes out the​ window and your mortgage's monthly payments are adjusted to​ begin repaying the​ negative amortization debt.
Factors that can go either way
There are a​ few factors of​ adjustable rate mortgages that can fall on​ either side of​ the​ pro/con debate .​
Due to​ the​ fact that there are many different types of​ adjustable rate mortgages available from different lenders,​ it's important that you​ research the​ adjustable rate mortgage and find out whether it​ is​ right for you​ .​
Some of​ the​ 'ambiguous' factors that you​ have to​ consider can make or​ break the​ decision to​ go with an​ adjustable rate mortgage.
One of​ the​ first things you​ need to​ consider is​ the​ lifetime interest rate cap on​ the​ mortgage .​
This is​ the​ maximum amount that the​ interest rate can raise through the​ period of​ the​ mortgage .​
There are also the​ periodic adjustment caps that limit the​ amount that your mortgage interest rate can raise from one adjustment period to​ the​ next .​
The law states that adjustable rate mortgages have some type of​ lifetime cap .​
Most lenders use one of​ the​ index rates to​ base their interest rates on​ .​
The index rates change and fluctuate with the​ movement of​ the​ economy .​
To determine the​ interest rate that you​ will be charged,​ the​ lender adds a​ margin (profit percentage) to​ the​ index rate .​
The margin that the​ lender will add is​ also important - it​ determines your future interest rates with an​ adjustable rate mortgage .​
The margin is​ different from lender to​ lender,​ so it's important to​ find out what the​ margin is.
The Pros And Cons Of Adjustable Rate Mortgage The Pros And Cons Of Adjustable Rate Mortgage Reviewed by Henda Yesti on July 04, 2018 Rating: 5

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