Adjustable Rate Mortgages – ARM Loans

An adjustable rate mortgage, or ARM loan, is a mortgage loan where the interest rate is tied to and therefore governed by any of a number of indices. The interest rate is periodically checked and updated according to the index that is used and the frequency in which the rate is checked is determined by the loan term. ARM loans can be easier to attain during difficult economic times but they may lead to higher repayments in the future compared to those first agreed.

ARM Loan Indices

The ARM loan can be tied to a variety of different indices and choosing the best adjustable rate mortgages means making a judgment on the best index to work with. In the USA, common indices include Constant Maturity Treasury securities but there are many others available too. Some lends may use their own costs as their index which ensures that the lender has a strict margin of profit throughout the period of the loan.

Reduced Interest Repayments – Greater Risk

As with many financial products, the consumer is afforded reduced payments at the cost of greater risk. The risk lies in the fact that future repayments could rise if the tracker index also rises. However, if the index remains stable or reduces then the borrower continues to enjoy reduced rate repayments compared to a fixed rate mortgage or loan.

Index Rates And Margins

When looking for ARM loans there are several factors to consider. The index rate and margin combine in order to determine how much interest needs paying so you should carefully consider both of these. A smaller margin means you pay closer to the index rate, so would make lower repayments compared to a similar product with a higher margin.

Introductory Offers

In order to make ARM loans more attractive, many lenders offer a teaser interest rate which is considerably lower than the indexed rate. This teaser rate will usually be applied for a number of months before the rate is recalculated at the prevalent indexed rates and the new repayment level is set.

Adjustment Period

The adjustment period is the number of months that the interest rate will remain unchanged. Following this period of time, the interest rate is recalculated and the adjustment period begins again.

Interest Rate Caps

Caps may be applied to one or more of these factors to prevent too high a rise or drop in interest rates. Some adjustable rate mortgages, for example, may place an annual interest rate cap of 2% meaning that the interest rate may not change by more than 2% in a single year. Others may place a cap on how often the interest rate is allowed to change in a year.

Choosing Adjustable Rate Mortgages

Adjustable rate mortgages have proven popular as many indices have dropped significantly in prevalent market conditions. There is always the risk of the indexed interest rate rising but borrowers take on that risk in exchange for the benefit of reduced initial repayments. Always be sure to read the terms of any loan paying particular attention to the caps, index rates, and margins associated with ARM loans.