Understand What Adjustable Rate Mortgages are Before Selecting A House

An adjustable-rate mortgage (ARM) is different than a fixed-rate mortgage in many ways. Many homeowners came to understand that reality in the last few years, which is why it is so important to understand ARMs before buying a house. Although they knew it was possible for their monthly payment to increase, most people with ARMs had no serious expectation that it would happen during a slow economy. With a fixed-rate mortgage, the interest rate stays the same during the entire life of the loan, meaning monthly payments stay the same. With an ARM, the interest rate changes periodically, annually or more often, and payments may go up or down according to a financial index, a statement of the overall economy. That is how many homeowners with ARMs got caught without enough income to make their house payment after they had been making payments for a couple years.

To make sure you understand how a change in interest rate could affect you when you're buying a home and you're comparing two different ARMs, or you're comparing an ARM with a fixed-rate mortgage, you need to know the following: several published financial indexes reflecting what is happening in the US and world economies, as well as margins, discounts, caps on rates and payments, negative amortization, payment options, and recasting (recalculating) of your loan. Many complex factors affect changes in your payment amount, so you need to consider the maximum amount your monthly payment could increase. Most people don't want to think about their payments going up, it's not a pleasant thought, especially when money is tight in a difficult economy.

Because lenders usually charge lower interest rates for ARMs than for fixed-rate mortgages in the first few months or years, an ARM can result in lower payments than a fixed-rate mortgage for the same loan amount. And it's possible that your ARM could be less expensive than fixed-rate mortgage in the long run--for example, if interest rates remain steady or move lower. But that is a risk with a very steep downside.

You have to weigh the risk that an increase in interest rates would lead to higher monthly payments in the future, sometimes much higher payments. It's a trade-off--you get a lower initial rate with an ARM in exchange for assuming more risk over the long run. You have to ask yourself the following questions:

1) Is my income high enough, or is it likely to increase sufficiently to cover higher mortgage payments if interest rates go up?

2) Will I be taking on other debts such as a loan payments for a car, tuition or home improvements in the future?

3) How long do I plan to own this home? (This is a real consideration if you plan to sell within a couple years because rising interest rates may not affect you.)

4) Am I planning pay my mortgage loan off early?

To sum it up, it is truly important to understand adjustable rate mortgages before buying a house.


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