If you are in the process of purchasing a home or refinancing a loan you will want to explore the Adjustable Rate Mortgage. Here is what you need to know about this type of loan and how to get one:
- Adjustable Rate Mortgage: What is it? An adjustable mortgage is a loan where the interest changes periodically based on the fluctuations in an index. All ARMs are associated with indexes. They usually offer a fixed rate for a period of time of three to five years. After the term, the rates are subject to market changes. Adjustables are usually structured in a “3/1” or “5/1” manner-meaning you have a lower rate for the first few years then the interest can adjust every year afterwards depending on market indicators.
- Pros. ARMs, as they are coined, are a great choice for borrowers who think their monthly income will increase and those that could use the extra cash flow in the immediate time. The interest rates are usually lower than a fixed mortgage. In some instances rates will go down in the duration of your lease. If this is the case, you luck out without having to refinance.
- Cons. ARMs, unlike fixed mortgages, are subject to the factors of the index they are attached to. If you are planning on living in the home you have purchased for more than five years, an ARM may not be the way to go. Fixed mortgages present the borrower with a predictable cost schedule for the duration of the loan. Adjustable rate loans, on the other hand, can fluctuate and are directly influenced by market values and trends; if rates go up during the life of your loan, you will experience an increase in monthly interest payments with the ARM.
- “3/1.” This mortgage means that you will be locked in a rate for 3 years, and every year after that you may experience a change in rate. This can be an increase or decrease. You may choose to refinance before the three years are up, or you may opt to go with the rate change.
- “5/1.” This mortgage will have you locked in a rate for 5 years, and in the following year the interest percentage can go up. Like the 3/1, your loan is subject to the changes in the index after that 5th year. People in 5/1s tend to refinance within the first several years to get a more attractive loan before their 5 years is up. The rate on a 5 year will usually be higher than a 3/1.
- How to get a rate. Shop around at different lenders and explore their rates. Inquire about their 3/1 and 5/1 plans. Approach several mortgage brokers and decide on a rate you like. Make sure you like the lender and not just the number. You need to be confident in his ability to produce the commitment when push comes to shove (meaning, the rate he quoted should be the one you receive).
- Fill out, lock and sign. The lender will require you to fill out a series of papers. The loan, once locked in, will go into underwriting and will be processed. Once you are “locked in,” your lender will provide you with information regarding your mortgage. If you are closing on a home, your payments will start after the closing. If you are refinancing, they will occur as it is defined in the loan. Ask your broker about the specifics of the loan, the monthly amount due, late fees, and if there are prepayment penalties.
Now all you have to do is pay your monthly payments on time! Good luck.