What is an Adjustable Rate Mortgage (ARM)?
Borrowers who are willing to accept the risk of interest rate increases can usually cut their initial payments with an ARM. There is evidence that customers choose contracts with the lowest starting rates, such as in the United Kingdom, where customers are more concerned with monthly mortgage expenses. Consumer decisions may also be influenced by the advice they receive, and most of that advice comes from lenders who may prefer ARMs due to financial market dynamics.
How does an Adjustable Rate Mortgage work?
Adjustable rates shift some of the lender’s interest rate risk to the borrower. They can be employed in situations where fixed-rate loans are difficult to come by due to fluctuating interest rates. If the interest rate reduces, the borrower profits; however, if the interest rate rises, the borrower loses. When opposed to fixed or capped rate mortgages, the borrower benefits from lower margins on the underlying cost of borrowing.
The lender’s standard variable rate/base rate may be applied to the loan. Although there may be a direct and legally defined link to the underlying index, the rate can be altered at the lender’s discretion if there is no specific link to the underlying market or index. The term “variable-rate mortgage” is most commonly used outside of the United States, whereas “adjustable-rate mortgage” is most commonly used in the United States, and denotes a federally regulated mortgage with charge caps. Adjustable rate mortgages are the standard in many nations, and they are simply referred to as mortgages there.
Definition of an Adjustable Rate Mortgage
A variable-rate mortgage, also known as an adjustable-rate mortgage (ARM), or tracker mortgage, is a loan with an interest rate that is altered on a regular basis based on an index that represents the cost of borrowing on the credit markets to the lender.
Features of an Adjustable Rate Mortgage
- Initial interest rate. An ARM’s starting interest rate is this.
- The adjustment period. This is the amount of time that an ARM’s interest rate or loan duration is expected to stay the same. At the end of this period, the rate is reset, and the monthly loan payment is computed.
- The index rate.The majority of lenders connect changes in ARM interest rates to changes in an index rate. Lenders base ARM rates on a number of indexes, with rates on one-, three-, and five-year Treasury securities being the most prevalent. The national or regional average cost of funds to savings and loan associations is another typical measure.
- The margin.The percentage points added to the index rate by lenders to determine the ARM’s interest rate.
- Interest rate caps. These are the maximum changes in interest rate or monthly payment that can be made at the end of each adjustment period or over the life of the loan.
- Initial discounts. These are interest rate discounts granted for the first year or more of a loan, which are frequently utilized as promotional tools. They lower the interest rate to below the current rate (the index plus the margin).
- Negative amortization. This indicates that the mortgage balance is rising. This occurs when the monthly mortgage payments are insufficient to cover the entire amount of interest owing on the loan. This can happen if the ARM’s payment cap is low enough that the principle plus interest payment exceeds the payment ceiling.
- Conversion. A stipulation in the loan agreement with the lender may allow the buyer to convert the ARM to a fixed-rate mortgage at specified dates.
- Prepayment. If the ARM is paid off early, some agreements may compel the buyer to pay additional fees or penalties. Terms of prepayment are occasionally negotiated.
Adjustable Rate Mortgage Calculators
Use our Adjustable Rate Mortgage Calculator Virginia that will provide competitive interest rates, but your payment is not guaranteed. This adjustable-rate mortgage calculator will help you estimate your potential adjustable-rate mortgage payments. At the end of the term, the monthly payment is calculated to pay off the total mortgage balance. Typically, the period is 30 years. The interest rate and payment adjust at the frequency set after any fixed interest rate period has ended.
For further information on Adjustable Rate Mortgages, contact the mortgage experts at Mortgage Rates Today!
Last Updated on 05/25/2022 by Mark Verhoeven
Financial Consultant and Author