| Adjustable rate mortgages can impact your payment over the life of a loan. Having an adjustable rate home loan means that your monthly payment amount will adjust up or down periodically. Rates adjust at pre-determined periods (a 1 year ARM adjusts at the end of 1 year, for example).
Whether your mortgage payment increases or decreases is dependent upon many factors. According to The Federal Reserve Board, these factors include:
The interest rate, which combines the index and margin. The index is a measure of interest rates. There are several indexes that lenders may use. Some of these include rates on 1-year constant maturity Treasury securities (CMT) and the Cost of Funds Index (COFI).
It is a good idea to ask your lender about the index or average of indexes that will be used in calculating your adjustable mortgage rates. There are also many adjustable rate mortgage calculator programs you can use to determine your monthly mortgage rate. You can use this information to review the history of changes for the index and make reasonable predictions about future changes. Your predictions may not be exact, but they may steer you away from adjustable rate mortgages most likely to push payments beyond your reach.
The margin is the percentage points added to the index. When comparing loans, you should know that the percentage points added can vary with lenders. Your credit history also is a factor. Borrowers with strong credit histories generally enjoy the privilege (and savings) of lower margins.
When considering adjustable rate mortgages, take into account the following:
- The index and margin – These will significantly impact your payments throughout the life of the loan.
- The floor and ceiling interest rate for your adjustable rate home loan – Lenders are eager to tell you how low the loan may go. You should also ask how high the loan could go. You should ask about the floor and ceiling for each adjustment period as well as for the life of the loan.
- The length of time you plan to be in your home – Borrowers that plan to sell in the short term may be less concerned about long term payment fluctuations.
- The total cost of the loan, including any associated fees or penalties. Use an adjustable rate mortgage loan calculator, consult application documents and talk with your lender to make the most informed decision.
As with any loan or major purchase, there are cautionary considerations. When considering an adjustable rate mortgage, take heed of the following:
- Adjustable Rate Mortgage loans require careful financial planning and consideration. Be sure that future income and expenses will allow for any payment increases.
- Some borrowers with adjustable mortgage rates may be surprised to find that they owe more than they borrowed. Ask your lender how payment caps and future interest will affect your adjustable rate home loans.
- The monthly mortgage payment on your adjustable rate home loan may not decrease even if interest rates fall. Make sure you get all the adjustable rate mortgage information from your lender including information about the APR or annual percentage rate for your loan.
According to The Federal Reserve Board, “the APR is the cost of your credit as a yearly rate. It takes into account interest, points paid on the loan, any fees paid to the lender for making the loan, and any mortgage premiums you may have to pay.”
You may be able to take advantage of a conversion clause if you aren’t sure what the future holds. This clause allows you to change your adjustable rate mortgage to a fixed rate mortgage for a fee.
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