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Adjustable Rate Mortgages - ARM Vs Fixed Rate - What to Consider When Shopping For a Mortgage
By Jon Gomenz
High costs of housing have made it a general rule for people intending to buy a home to apply for a home mortgage. Arranging proper finances for a mortgage is perhaps the most arduous task while venturing to build and own your house. Proper finances here implies that a borrower has full knowledge of the various mortgage options available in the market and selects the best one that suits his financial needs. It requires a lot of due diligence on the part of a loan applicant before deciding on a particular form of loan or mortgage as there are any number of mortgage choices available. Shopping for a mortgage becomes pleasant when an individual learns everything about various mortgage options and picks the one that matches his financial and housing plans. Knowledge about mortgages that can be acquired through reading and discussing with mortgage or investment professionals is vital here as there any number of apparently suitable mortgage plans that turn out to be financial drainers later.

Fixed Rate Mortgages

All different mortgage plans advertised, fall in to two families: fixed and adjusted rate mortgages. Fixed rate mortgage is one in which the interest rate remains fixed over the period of the loan. It is the most classic form of housing finance in the USA. The period of loan may be 15, 20 or 30 years, though usually fixed rate mortgages are taken for 30 years. The longer the period of mortgage lower will be monthly installment paid. But the total interest paid increases with the increase in the time period. You will pay less overall with a short term loan, but the monthly installments will be high.

Adjustable Rate Mortgages

Adjustable rate mortgage as the term suggests is a mortgage type where the interest rate is adjusted as per the changes in the bank prime rate and other market conditions. The interest rate in adjustable rate mortgage is usually tied to a money market index, determined usually by the Treasury bill, Bank Prime Loan, Fannie Mae’s Required Net Yield, National Average Contract Mortgage Rate etc. The lender adds 1.5 to 2.5 percent to the index to determine the adjustable rate mortgage. Interest rate in the adjustable rate mortgage changes when the market index changes, but the lender and borrower will agree how often to effect changes in the terms of the loan. Though one year is the norm to adjust interest rates, there are provisions to adjust within one month to ten years.

Adjustable rate mortgages should mean a free changing interest rate as per the change in the index interest rate. But actually it’s not so. There is a cap to the interest rate adjustment meaning interest rate will change within a limit at any time during the period of a loan. For instance, if the index interest rate falls by 6 percent the interest rate in adjustable rate mortgage will not be brought down 6 percent. It may be brought down by 3 or 4 percent as agreed by the lender and the borrower. Some ARM’s come with a payment cap which specifies the maximum amount a borrower will pay over the life of the loan. This is specified in dollars rather than percentages. There are also many ARM’s with a conversion option which means that they can be converted in to fixed rate mortgages after a period of time. A conversion fee is charged for this and in some cases it makes sense to obtain an adjustable rate mortgage.

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