Adjustable Rate Mortgages: This Home Mortgage Loan May Not Be For The Weak At Heart
Written by: Vishy Dadsetan
I heard the news about another interest rate hike and thought it
was about time to look into refinancing my mortgage. I contacted
my mortgage company first.
"I am interested in a fixed mortgage rate." I said.
"May I ask why that is?" The broker asked politely.
"I don't want to deal with the risk of rising interest rates. At
my age, I cannot afford the risk."
"Looking at your last ten years of history, you have done pretty
well with the adjustable rate. In fact, you had paid less in
interest than most people with a fixed loan. May I suggest that
we look at some adjustable rates, which are even less than the
rate you're paying and with caps you don't have to worry about
the interest rate hikes. I think we can save you a few hundred
dollars off your monthly payment."
At this point the broker took a breather so that I can say, "No
thank you. I am only interested in a fixed rate mortgages." "I
don't understand. Are you not interested in saving money?" He
asked before launching into a lecture that had a mix of economy
101, budgeting 1, a dash of fortune telling and a healthy and
totally unrealistic optimism of future trend in interest rates.
When he was done I explained to him that I recall the 18%-19%
interest on mortgage loans in the early 1980's that he seemed
too young to remember. I pointed out that on a $100,000 loan,
the 18% interest is $1,500 per month on the mortgage interest
alone. If you have a $200,000 loan the interest alone would be a
back-breaking payment of $3,000 per month.
I knew he thought I am out of my mind thinking about an 18%
mortgage interest rate in today's environment. At the end we
ended the phone conversation without any resolution. The gap in
understanding wasn't about fixed rate mortgages vs adjustable
rate mortgages (ARM). The gap was in age, experience,
expectation, hopes and fears; a gap too wide to bridge.
To understand this gap, let's look at the adjustable rate
mortgages. This type of mortgage loan is usually lower than the
fixed rate and the lower rate means lower payment that in turn
means easier qualification.
When lenders are considering your mortgage loan application,
they look at what percentage of your income is available for
repaying their loan. With an income of $5,000 per month, a
$2,000 loan payment is 40% of your income and a $1,000 payment
is 20% of your income. The closer you get to $1,000 or 20% of
your income, the easier it is to qualify for the loan. This
easier qualification appeals to younger people who are just
starting and those with income limitation.
Adjustable mortgage rates appeal to young people with an innate
optimism, hopes of increased income and the high possibility of
moving to a different home in a short period of time. They need
to look at what they can afford to pay and cannot worry too much
about the distant future. To them anything is better than
renting which is absolute waste of money.
There are also those older individuals who have suffered from
some set back in life and do not enjoy a high credit score or do
not have a very high income. Since a poor credit score increases
the interest rate a bank offers to potential borrowers, a fixed
rate may be too high for these individuals to consider.
Let's take a look at some terms that help you understand ARM
Margin - This is the lender's markup and where they make their
profits. The margin is added to the index rate to determine your
total interest rate.
ARM Indexes - These are benchmarks that lenders use to determine
how much the mortgage should be adjusted. The more stable the
index is the more stable your adjustable loan remains. Consider
both the index and the margin when you are shopping around.
Adjustment Period - Refers to the holding period in which your
interest rate will not change. You will come across ARM figures
like 5-1 that means your mortgage interest remains the same for
five years and then it will adjust every year.
Interest Rate Caps - This is the maximum interest a lender can
Periodic caps - The lenders may limit how much they can increase
your loan within an adjustment period. Not all ARMs have
periodic rate caps.
Overall caps- Mortgage lenders may also limit how much the
interest rate can increase over the life of the loan. Overall
caps have been required by law since 1987.
Payment Caps - The maximum amount your monthly payment can
increase at each adjustment.
Negative Amortization - In most cases a portion of your payment
goes toward paying down the principal and reducing your total
debt. But when the payment is not enough to even cover the
interest due, the unpaid amount is added back to the loan and
your total mortgage loan obligation is increased. In short, if
this continues you may owe more than you started with.
Negative amortization is the possible downside of the payment
cap that keeps monthly payments from covering the cost of
As you compare lenders, loans and rates remember Henry Moore who
said, "What's important is finding out what works for you."
About the author:
Vishy Dadsetan writes articles that can actually help your
clients. Articles that make sense. Articles just like this one.
Additional information is available at: Adjustable Rate Mortgage
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