Adjustable Rate Mortgage

Unlike fixed rate mortgages which have a "fixed", unchanging interest rate and monthly payment for the term of the loan, an adjustable rate mortgage has initial fixed interest rates and monthly payments, but then adjusts periodically. In general, adjustable rate mortgage products offer lower interest rates than fixed rate mortgages. In exchange for a lower interest rate, the borrower takes on more risk with a loan that adjusts after the initial fixed rate period. An adjustable rate mortgage is determined by an economic index and a margin. The index used is a guide for lenders to assign an interest rate to the loan. Many different economic indexes are used but the Treasury securities, COFI, and LIBOR are among the most common. It is good to understand the index tied to your loan. The goal is to invest in a product linked to a historically stable index. After the initial fixed period of the loan, the interest rate and payments will fluctuate according to the activity of the index. A typical adjustable rate mortgage term offered is 1/1, 2/1, 3/1, 5/1. The first number in each set refers to the amount of time the initial interest rate is fixed. The second number denotes how often after the initial period the rate adjusts. As you can see, the adjustable rate mortgage products listed adjust annually after the introductory period. An adjustable rate mortgage is a good product if you are planning to be in a home for a shorter period of time. At a lower interest rate, an adjustable rate mortgage could be less expensive in the short term. Rates are lower with adjustable rate mortgage products than with fixed rate mortgages, so borrowers may be eligible to borrow larger loan amounts. An adjustable rate mortgage is amortized over 30 years and often carries pre-payment penalties of 1, 2, or 3 years. This means that if you refinance again, sell your house, or pay off your loan within the allotted prepayment term, you will be assigned a penalty. Pre-payment penalties are, in general, equal to 6 months of interest payments on the mortgage.

Advantages Of an Adjustable Rate Mortgage
  • Lower initial interest rate than a fixed rate mortgage
  • Lower monthly payments
  • You could be eligible for a larger loan amount
  • You are planning on staying in your house for a short period of time
  • You are expecting your income to increase in the future
  • Available on owner occupied, second homes, and investment properties
Disadvantages Of an Adjustable Rate Mortgage
  • Interest rates and monthly payments will fluctuate after initial fixed period
  • You are planning on staying in your home for a long period of time
  • Loans often carry pre-payment penalties
  • You are unsure about future income
Types of Adjustable Rate Mortgages