Adjustable Rate Mortgages
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A vast majority of residential mortgages in this country feature a fixed interest rate. Another type, the adjustable rate mortgage, is less frequently used because it is much riskier for the borrower. As the name suggests, an ARM has an adjustable interest rate. Hybrid mortgages also involved adjustable Mortgage Rates , but only after an initial period where the interest rate is fixed.
The mortgage rate is essential for two reasons. First, it plays a huge role in determining the borrower’s monthly payment. In a fixed mortgage that amount will not change, so borrowers can expect to pay the same monthly payment. In an ARM, the mortgage rate will change, repeatedly, and so will the monthly payment. Second, the total cost of the mortgage depends on the mortgage rate, so the borrower doesn’t know how much the house is actually going to cost until they make the final payment and can back calculate how much they paid.
The schedule for each type of ARM is different. Some will recalculate the interest rate on a monthly basis while others use longer periods, like quarterly or semi-annually. Each ARM is calculated using a stated index. The three most commonly used indices are the Prime Rate, the LIBOR Index, and the Treasury Index. The actual formula and schedule for calculation will be outlined in the terms of the mortgage.
Borrowers sometimes seek out ARM or hybrid loans when they are purchasing property for development or investment. They plan to sell off the home or commercial real estate f or a profit and are betting that they can do so before the interest rate goes up. Since the borrower assumes such a high risk with ARMs, they should have a very good understanding of financial markets and the specific loan terms before committing to this type of mortgage.
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