ARM or Adjustable Rate Mortgage means that the interest rate of your mortgage loan fluctuates; meaning it can go up or go down, depending upon the market condition.
The ARM is made up of two parts. The first is the INDEX or that part of the interest rate that is forever changing as affected by inflation and different market factors and is not constant. This is often referred to as the benchmark interest rate. The other is the MARGIN (or a ‘spread’) which is the amount that a lender charges and is constant all throughout the term of the loan. Combining the two, index and margin, makes up the fully indexed rate of an adjustable rate mortgage.
The lender has no control over the rise and fall of the mortgage index. …show more content…
The interest rate cap comes in two forms:
• Periodic - a periodic adjustment cap limits the amount in which the interest rate can adjust up or down from one adjustment period to the next after the initial or first adjustment.
• Lifetime – a lifetime cap limits the interest rate increase over the life of the loan. The law requires all adjustable rate mortgages to have a lifetime cap.
In addition to the interest rate caps, most adjustable rate mortgages also have a cap on the amount your monthly payment may increase at the time of each adjustment, even if the interest rate rise more. In the event this happens, the difference between the adjustment and the payment cap will be added to the balance of the loan and this leads to a negative amortization.
Most adjustable rate mortgages that have payment caps do not have a periodic interest rate cap. In addition, most payment option ARMs have a built-in “recast” or recalculation period. Generally, this is every 5 years, sometimes 7 years. At that point, the monthly payment is recalculated based on the remaining term of the loan. So, if you have a 30 year term, but already at the end of year five, the monthly payment is recalculated for the remaining 25 years. The payment cap does not apply to this adjustment anymore. If the loan balance has increased or if the interest rate have risen faster than the payment itself, the monthly …show more content…
The question now is, “how can it benefit the borrower?” and “are there downsides to it?”
A borrower used to be able to afford to buy a more expensive house than they normally would using an adjustable rate mortgage. In today’s market though, a lender will use and calculate eligibility of the borrower based on the payment with future adjustments to qualify someone who insists on getting an adjustable rate mortgage. ARMs can be beneficial for the borrower especially at the start of the mortgage term because normally the interest rate starts low within the first couple of years of the term or before the first adjustment. It might have offered a teaser rate at the start. This means that for example, when you are already a bit ‘dry’ after spending money on buying a home, having a low interest rate will definitely help the first years of paying a low mortgage monthly payment. It can be a lifesaver. This can enable you to continue paying without much financial duress and may have extras to complete buying your furniture, repairs, fix the lawn and other home-related