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 Adjustable Rate

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