ARM Mortgage Options by Liz Suto
Mortgage options are getting more complicated, and the sheer number of mortgage products continues to befuddle home buyers. Fixed rate, adjustable rate (ARM), interest only, negative amortization, and more mortgage types are out there, and many can be combined into one loan product.
When you give your mortgage broker an idea of the length you expect to stay in the home, the amount of money you have for a down payment, and the approximate price of the home you wish to buy, the broker should be able to give you a few options to narrow your choices.
If you are considering a loan where the interest rate adjusts (an ARM, or Adjustable Rate Mortgage), make sure you ask these questions of your mortgage broker:
How long is the mortgage interest rate fixed?
A "3 year Fixed ARM" or a "3/1 ARM" usually means that the interest rate will be fixed for 3 years. After that the interest rates will adjust yearly according to the index it follows.
How often will the rate change and how much can it change? Find out how often the interest rate will be adjusted, and the maximum amount it can change each adjustment period (sometimes called the periodic adjustment cap).
Let's say you are comparing two adjustable rate mortgages on a $200,000 loan. One is an ARM where the interest rate is fixed for 1 year and may change every year after that, and the other loan is an ARM which is fixed for 5 years (often written as 5/1). Let's say you think you'll live in your home for the next 5 years. The following table shows payments for both loans:
| 1/1 ARM 5.75% | 5/1 ARM 6.875% | |
| 1st year monthly payment | $1,167 | $1,247 |
| 2nd year monthly payment | $1,294 | $1,247 |
| 3rd year monthly payment | $1,424 | $1,247 |
| 4th year monthly payment | $1,555 | $1,247 |
| 5th year monthly payment | $1,689 | $1,247 |
| Total payments in 5 yrs | $85,548 | $74,820 |
| Total principal | $10,429 | $13,098 |
In this example, you pay less with the 5 year arm by about $10,000 in 5 years, and you managed to repay more principal, even though the first year's payment for the 1 year ARM was less by about $80 dollars each month. It's really a guessing game, though. Will rates continue to rise at 1% yearly? The 5 year ARM gives you some security, with a steady monthly payment.
What is the lifetime interest rate cap?
If interest rates go through the roof, what is the maximum amount your interest rate will increase? This cap protects you from an extreme circumstance where interest rates get outrageously high.
Copyright © 2006 by Liz Suto. Liz Suto is a professional writer, real estate agent and Anthem Arizona resident. Look for her articles at the PhoenixAz Insider website and in Phoenix area magazines and newspapers.
