Adjustable Rate
Mortgage Financing
Sources...
An adjustable
rate mortgage (ARM)
is yet another type
of adjustable
interest rate
mortgage.
Sometimes
referred as an
adjustable mortgage
home loan. It is more
flexible than the
VRM or RRM, there is
no limit on how far
and how often the
interest rate on an
adjustable mortgage
loan can fluctuate.
The main requirement
is that the rate on
the loan be tied to
some publicly
available index that
is mutually
acceptable to the
lender and the
borrower. For
example, yields on
Treasury bills or
the average cost of
funds to S&Ls as
published by the
FHLBB could be used
as an index. The
lender must also
carefully explain to
the borrower what
will happen if and
when rates rise and
fall over the life
of the loan and give
the borrower the
privilege of
repaying the loan
early without a
prepayment
penalty.
Rate Changes
There are three
ways to accommodate
a change in the
interest rate on an
existing ARM loan. The
first is to raise or
lower the monthly
payment by the
amount of the
change. The second
is to keep the
monthly payment
constant but shorten
or lengthen the
maturity. The third
is to keep the
monthly payment and
maturity constant
but change the
amount owed. In
response to consumer
concern that a loan
with no limits on
interest rate
increases could
produce unlimited
increases in monthly
payments, adjustable
rate mortgage regulations allow
lenders to set
interest rate and
monthly payment
caps. An interest
rate cap would be,
for example, an
agreement by the
lender to limit
interest rate
increases (or
decreases) to 2% per
year even though the
index being used
called for a change
greater than that.
With a
payment-capped loan,
the monthly payment
remains constant
even though the
index rises. If the
payment does not
cover the new
interest rate, the
excess is added to
the amount owed on
the loan. In other
words, there will be
negative
amortization of the
loan. To keep the
loan from growing
too large, a payment
adjustment is
scheduled from time
to time as agreed to
in the lending
contract. This might
be as often as every
six months or as
infrequent as every
five years. At that
time the monthly
payment is adjusted
to fully amortize
the loan over the
remaining
term.
The other
alternative,
extending the
maturity, is only
effective if the
interest rate change
is a small one. For
example, extending a
maturity from 25 to
40 years will
accommodate an
interest increase of
less than 1%.
Moreover,, a lender
may not be willing
to extend a maturity
to 40 years due to
the age of the
mortgaged structure.
Because of these
problems, maturity
changes are little
used.
Some have called
unlimited interest
rate increases and
negative
amortization
legalized gambling.
Others point out
that as long as
banks and savings
and loans must rely
on short-term
deposits, they must
have equal
flexibility in the
rates they charge
their borrowers or
they will go out of
business. Ultimately
the borrower must
decide whether or
not the need to
borrow outweighs the
risks of rising
monthly payments.
The alternative to a
variable loan is a
fixed-rate loan.
Our recommendation:
Some ARMs, such as those that adjust every year, are too risky for unsophisticated home buyers. However a 30-year fixed-rate mortgage imposes unnecessary costs on borrowers who don't expect to be in their homes for more than a few years.
ING's most popular mortgage is a hybrid that adjusts after five years.
In our opinion it is
the best offer that
we have come across.
On a $250,000 mortgage, the hybrid ARM can reduce a borrower's monthly payments by about $200 over a fixed-rate, 30-year loan. "If you're not going to stay in the
house more than 3, 5
or 7 years, to pay that $200 would be a waste!
Adjustable
Rate Mortgage To
Shared Mortgage
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