In this article I will discuss some of the pro’s and cons associated with adjustable rate mortgages. ARM’s are mortgage loans that have a fixed rate for a specified period of time. 1/29, 2/28, and 3/27 are some examples. After the specified time period has ended, the interest rate on the loan begins increasing or decreasing determined by the index the loan utilizes. An index is used to measure inflation in the economy, some examples of index’s are the CODI, COFI, COSI, and LIBOR.

An adjustable rate mortgages have many benefits here are a few examples:

• If you anticipate your current income level increasing in the future to account for the higher payment when it begins adjusting.

• It will get you more easily qualified for a home that you may not otherwise afford, with a lower payment when compared to a 30 year fixed rate mortgage.

• Adjustable rate mortgages are good to use when the the real estate market in your area is experiencing an upward trend in appreciation.

• Flexibility in which index is utilized in your mortgage.

• If you qualify, an initial lower than market price “teaser rate,” can dramatically reduce cost of ownership during the first one or two years of ownership.

• Some Adjustable Rate Mortgages offer the the option to be converted to fixed-rate loans during a set time frame within the loan.

• The cost of the first year of ownership can be reduced significantly using the initial low teaser rate many ARM’s feature.

• The lender may permit special concessions to the buyer, such as no PMI or nor reserve accounts for taxes and insurance. This is due to a few lenders keeping ARM’s in portfolio.

Some of the disadvantages of ARM’s include:

• They are not ideal in times of high inflation, where long-term ownership is necessary.

• There is no security that the interest rate will remain low because indexes are reflections of the economy.

• If the buyers financial situation changes after the loan is cast, making the payments may become very difficult for the buyer.

• The buyer may overextend themselves, using the low initial rate payment as the basis for obtaining the loan, when the rate adjusts later, they may be unable to make the higher payments.

• The loan may contain a negative amortization clause, where any interest that is unpaid monthly is added back on to the principal balance.

• The buyer must be aware of the index the lender’s program is using, some index’s are more favorable than others.

• The margin may be unusually high. The margin is the lender’s cost of doing business plus profit, which is added to the index to create the interest rate, it is set at loan origination and remains constant for the life of the loan.

• Convertible arms have conversion fees for changing the interest to a fixed rate; which is based usually on the note rate for that particular investor(i.e. FNMA securities) plus an additional ｽ to 5/8 % interest.

I hope that this article has been helpful and in future articles I will discuss some of the basics of understanding adjustable rate mortgages.

Kevin Fenderson is a Realtor and Loan Officer with Hilltop Realty based in Santa Ana, Ca.

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