Adjustable rate loans are loans that have a rate, which can adjust throughout the course of the loan’s repayment, depending upon the movement of the specific Index. For example, a commonly used Index is the one-year Treasury Bill. Adjustable rate loan programs may initially offer a lower interest rate than a fixed-rate mortgage. This makes them attractive to people whom, by taking the lower initial interest rate, qualify for a larger mortgage. People who can benefit from an adjustable rate loan are people planning on moving or refinancing within the next five years, people with high probability of increasing their income, and people who need a low initial interest rate in order to qualify for their mortgage.

Before someone applies for an ARM it is important for that person to ask about the interest rate caps. Arms typically have 2 caps on how high or low the interest rate can adjust which also affects how high or low the mortgage payment adjusts. One cap sets the most that your interest rate can go up or down during the entire life of the loan. Caps of 2 percent per adjustment and 6 percent over the life of the loan are common. If your loan starts at 5 percent and the per adjustment cap is 2 percent, then your interest rate for that adjustment period cannot go higher than 11 percent over the life of the loan. It is important for one to discern what their comfort level is if the mortgage payment was at the highest rate adjustment in the future.

There are several types of ARM loans available. These include the following:

Standard Arm
This loan is available with initial rates that are fixed for 1, 3, 5, 7 or 10 years. When the initial period is up, then the loan will adjust based on a formula, which varies from program to program. The rate caps are typically 2 percent per adjustment and 6 percent over the life of the loan.

Balloon
These are available with initial rates that are locked in for 5 to 7 years. Whatever the remaining amount on the loan is due in full at the end of the rate period.

Negative Amortization Loans
These loans do not payoff the principle or the full amount of interest that is due. Negative amortization is a loan payment schedule in which the outstanding principle balance goes up rather than down. This loan allows for the lowest possible payment that you can make.

Buy-Downs
This program is based on the standard ARM program, but allows for reduced interest payments for the first couple of years. The reduced interest lowers the mortgage payment and may allow someone to qualify for a loan that they otherwise would not have qualified for at a higher rate. The borrower is responsible for paying the difference between the below market rate of the loan and the initial rate. This can be done with either a lump sum in escrow or by paying the required points on the loan. Be sure to consult with an independent financial advisor when deciding upon which loan type is applicable to your situation.

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