Adjustable rate mortgages are a way to save money, especially if you expect to sell your home fairly quickly. Adjustable rate mortgages (ARM) have a period of time where the rate is fixed. A 1 year ARM has a fixed rate for a year. A 7 year ARM has the initial rate fixed for the first 7 years.
The rates are tied to an external index. The margin is the percentage points added to the that index to arrive at a rate. For example if your ARM is tied to the 1 year Treasury Bill (T-bill) interest rate and the loan margin is 2.75%, then the rate you pay would be the T-bill rate plus 2.75%.
Generally, the longer the fixed period, the higher your margin will be. The lending institution is making the assumptions that they’ll cover the risk of increased rates during the fixed period by the higher margin once the rate floats. This works in your favor if you sell your home before the variable rate kicks in.
With a loan like a 7 year ARM, take some time to work out the calculations. Because the fixed rate period is long, there might not be enough savings in the interest rate to offset the risk of high rates. If you sell your home, there is no risk but a lot can happen in 7 years. Plans you made not pan out. Things you thought were certain might fade away.
Mortgage calculators are available on the internet. You can look up interest rates and play around with amounts, rates, indexes and rates of change.
If you understand who margins, initial rates and caps all influence how much you pay, you’ll ensure that whatever loan you sign up for is one that works for you.
All lenders aren’t the same. It’s a good idea to shop around not only for the terms of the mortgage but also for the rates. When you shop around make sure you’re comparing apples to apples. If one lender has a great introductory rate on a 7 year ARM, make sure you look at details like the margin, the annual cap and the life-of-the-loan cap.
A low introductory rate can be costly in the long run if the maximum rate is high and rates go up precipitously. Of course, the opposite might also happen. You could sign up for a loan and interest rates go down, leaving you with a lower monthly payment. Interest rates have been at historic lows, so chances are that your rate will go up, not down over time.
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