Adjustable rate mortgage
An adjustable rate mortgage or variable rate
mortgage is a loan secured on a property (house)
whose interest rate and so monthly repayment
vary over time. Other forms of mortgage loan
include interest only mortgage, fixed rate mortgage,
Negative amortization mortgage, discounted rate
mortgage and balloon payment mortgage. Adjustable
rates transfer part of the interest rate risk
from the lender to the borrower. They can be
used where unpredictable interest rates make
fixed rate loans difficult to obtain. The borrower
benefits if the interest rate falls and loses
out if interest rates rise.
Variable rate mortgages are the most common
form of loan for house purchase in the United
Kingdom but are unpopular in some other countries.
Variable rate mortgages are very common in Australia
and New Zealand. For those who plan to move
within a relatively short period of time (three
to seven years), they are attractive because
they often include a lower, fixed rate of interest
for the first three, five, or seven years of
the loan, after which the interest rate fluctuates.
Adjustable rate mortgages, like other types
of mortgage, may offer the ability to repay
principal (or capital) early without penalty.
Early payments of part of the principal will
reduce the total cost of the loan (total interest
paid), and will shorten the amount of time needed
to pay off the loan. Early payoff of the entire
loan amount (refinancing) is often done when
interest rates drop significantly.
Adjustable rate mortgages are sometimes sold
to unsophisticated consumers who are unlikely
to be able to repay the loan should interest
rates rise, which they often do. In the United
States, extreme cases are characterized by the
Consumer Federation of America as predatory
loans. Protections against interest rate rises
include (a) a possible initial period with a
fixed rate (which gives the borrower a chance
to increase his/her annual earnings before payments
rise); (b) a maximum (cap) that interest rates
can rise in any year (if there is a cap, it
must be specified in the loan document); and
(c) a maximum (cap) that interest rates can
rise over the life of the mortgage (this also
must be specified in the loan document).
* 1 The Hybrid ARM
o 1.1 What is the difference between a hybrid
and a traditional ARM
o 1.2 The benefits
o 1.3 The risks
* 2 Terminology
o 2.1 Understanding Caps
o 2.2 Crucial Information About Caps
* 3 External links
The Hybrid ARM What is the difference
between a hybrid and a traditional ARM
The dominant loan product in today's marketplace.
They are often packaged as the 5/1 ARM or the
2/28 ARM (most popular products). The loan is
a "Hybrid" because a true ARM adjusts
for the same periods for the life of the loan,
ie. a 6 Month ARM is fixed for the first six
months and adjusts every six months afterwards.
The 2/28 "Hybrid ARM" is a 6 month
ARM that the borrower has purchased a "Rate
Lock" or introductory rate for the first
2 years (this is also done in 3,5,7 year fixed
periods), and then the loan becomes a 6 month
ARM thereafter, rather than a loan that does
only adjust every 2 years.
The benefits
This loan product has actually lowered the costs
of borrowing in the early years of loans, but
certainly is a source of continuing refinance
business to the Mortgage industry. They let
borrowers take advantage of special pricing,
by saving money on payments a) when the borrower's
salary is rising such as for young professionals
or b) when the borrower knows they are going
to move up quickly from one home to another.
The risks
If a borrower is inconsistent in their on time
payment history, afflicted by tragedy which
causes a credit problem, or keeps insufficient
funds in reserve (the payment savings from the
lower rate for example), as referenced above,
the rates in Hybrid ARMs will certainly rise,
and with insufficient credit and income, the
borrower may be forced to trade equity for time,
and in some markets, not as advantageously as
today.
VA Adjustable Rate Mortgages and VA Loans http://www.adjustable-mortgages.com
Terminology
* Fully Indexed Rate - The price of the ARM
as calculated by adding Index + Margin = Fully
Indexed Rate. This is the interest rate your
loan would be at without a Start Rate (the introductory
special rate for the initial fixed period).
This means, your loan would be higher today
if it was adjusting, typically, 1-3% higher
than the introductory rate. Calculating this
is IMPORTANT for ARM buyers, since it helps
you predict the future interest rate of your
loan.
* Margin - This refers to the banks profit margin
above the value of the financial index. The
bank seeks to make a profit above the costs
of inflation. The index is a measure of the
cost of funds as measured by inflation.
* Index - A publicly published financial index
such as LIBOR (usually 1 month, 6 month or 12
month), 11th District Cost of Funds Index, MTA,
etc.
* Start Rate - The introductory rate provided
to purchasers of ARM loans for the initial fixed
interest period. The difference between the
"Start Rate" of an ARM and the rate
of a fixed terms loan is that the "Start
Rate".
* Period - This is the frequency of adjustments,
the longer the rate remains fixed, the better
the loan is for the borrower. Typically, the
shorter this is the lower the rate, since there
are more opportunities to adjust upwards.
* Floor - A clause that sets the minimum rate
for the interest rate of an ARM loan. Most loans
come with a Start Rate = Floor feature, but
this is primarily for Non-Conforming (aka Sub-Prime
or Program Lending) loan products. This prevents
an ARM loan from ever adjusting lower. An "A
Paper" loan typically has either no Floor
or 2% below start.
* Payment Shock - Industry term to describe
the severe (unexpected or planned for by borrower)
upward movement of mortgage loan interest rates
and its effect on borrowers. Sadly, for those
that do not read this wiki entry or who do read
it but cannot understand its contents, they
may experience it, or spend too much of their
incomes to borrow on fixed terms only. See Caps
below
* Cap - Any clause that sets a maximum change
for the interest rate of an ARM loan.
Understanding Caps
* "The Caps" - In industry slang,
there you could ask for the Caps of a loan,
and if your broker or loan officer is intelligent
enough to read the rate sheets they are quoting
from, it is ALWAYS displayed and available.
This is basic stuff, the ABC's of mortgage lending,
if you're working with someone that can't or
won't explain this to you, go elsewhere.
* What's better? - The lower these numbers are,
the better for you, especially, the first number.
Examples: 2/2/5 ; 5/2/5 ; 2/1/6 ; 3/1/6 ; 2/4
; 1/1/5 .
The first number is the initial change cap,
the second is the periodic cap, the last is
the life cap. When only two values are given,
this always means the initial change cap and
periodic cap are the same. The longer the initial
fixed period, typically, the higher the caps
are given.
* Initial Change Cap - ARM loans have a specified
maximum first adjustment that is typically higher
than allowed on subsequent changes.
* Periodic Change Cap - The maximum interest
rate adjustment for every subsequent periodic
adjustment.
* Life Cap (Ceiling) - The maximum upwards adjustment
of an ARM loan. Typically on first mortgages
no more than 6%.
Crucial Information About Caps
Loan caps provide payment protection against
payment shock. Most First Mortgage loans have
a 5% or 6% Life Cap. Higher risk products, such
as Monthly Adjustable loans with Negative amortization
and Home Equity Lines of Credit aka HELOC have
different ways of structuring the Cap than a
typical First Lien Mortgage.
* First Lien Caps with no Negative amortization
Most First Mortgage loans have a 5% or 6% Life
Cap. If the adjustment period is 6 months or
1 year ( the two most common periods on the
market), then it takes anywhere from 2-4 maxiumum
upward adjustments to reach this cap
* Negative amortization ARM caps
See the complete article for the type of ARM
that NegAM loans are by nature. Most of them
are Monthly Adjustable ARMs and the life cap
or ceiling is simply expressed as a maximum
rate, usually 9.95% or 10.95% these days. Beware
though, some of these loans have 14-16% ceilings,
you have to ask . . . . The fully indexed rate
is always listed on the statement, but borrowers
are shielded from the full effect of rate increases
by the minimum payment, until the loan is recast
* Home Equity Lines of Credit HELOC
Since HELOCs are intended by banks to primarily
sit in second lien position, they normally are
only capped by the maximum interest rate allowed
by law in the state they are issued in! In Florida,
for example, this is 18% ! Wow!
Sadly, most people do not take the time to learn
about their ARM product, and some people even
take these loans out as their First Lien loan,
putting their house in jeopardy of foreclosure
if there is an inflationary market.
