With the record-low interest rate environment that we find ourselves in these days, adjustable rate mortgages (ARMs) seem to be more attractive than ever. After all, ARMs often have lower rates than their fixed rate counterparts.
However, there are a few things that buyers should take into consideration before getting into an ARM.
ARMs have a fixed period in the beginning of the loan.
The lower-rate mortgages are usually the ones with the shorter initial terms.
Rates will fluctuate with indices such as Treasury bills, or the London Inter-Bank Offer Rate (LIBOR), which is the interest rate that banks charge each other for loans.
ARMs adjust only at specific intervals, such as once per year, and rates can change only a certain amount at each interval.
They have what are called floors and ceilings.
One of the biggest misconceptions people have about ARMs is that, because the rates are low, they only need to qualify for the initial rate.
This is no longer the case.
For example, if you are looking at a mortgage with an initial rate of 3.5%, but it has a ceiling or lifetime high rate of 9.5%, you will now need to qualify for the payment as if it were 9.5%.
This accomplishes a couple of important things.
First, it takes the guesswork out of wondering whether or not you will be able to handle the mortgage payment if it spikes, based on your current income.
Second, it also protects the lender in the event that the property loses significant value and you are unable to refinance to a lower rate due to equity issues.