First Chance Mortgage is dedicated to helping homebuyers receive the financing they need. When interest rates are going down, or you intend to keep the home for fewer than five years, an adjustable-rate mortgage in Loganville, GA, may be the right solution for you. An adjustable-rate mortgage, or ARM, is a loan with a variable interest rate that changes to stay in line with the prime rate or Treasury Bill rate.
ARMs protect borrowers with a ceiling, or maximum interest that borrowers can reset annually. These loans typically begin with a lower rate than fixed-rate loans, which acts as compensation against future fluctuations in interest. The distinguishing characteristics of an ARM are Index, Margin, Adjustment Frequency, Initial Interest Rate, Interest-Rate Caps, and Convertibility.
An ARM’s interest rate will increase or decrease based on the activity of publicly-traded indexes, which include:
- United States Treasury Bills (T-Bills)
- London Interbank Offering Rate Index (LIBOR)
- Certificate of Deposit Indexes (CODI)
- 12-Month Treasury Average (MTA or MAT)
- Bank Prime Loan (Prime Rate)
- The 11th District Cost of Funds Index (COFI)
- Cost of Savings Index (COSI)
- Bank Prime Loan (Prime Rate)
The margin is the percentage amount, fixed for the lifetime of the loan, that is added to the index and accounts for the lender’s profit.
Interest Rate = Index + Margin
Adjustment frequency, or reset date, reflects how often the interest rate changes. Most adjustable-rate mortgages’ rates vary yearly, but some can adjust as frequently as monthly or as infrequently as every five years.
Initial Interest Rate
The initial interest rate is the amount that the borrower pays until the first reset date. The initial rate determines your monthly payments, and the lender may use it to qualify for the loan. This rate is usually less than the sum of the current index plus the margin, so monthly payments will likely increase after the first reset date.
Interest rate caps limit how much your ARM’s rate can increase or decrease. Common interest rate caps include:
Initial Adjustment Cap
This limits how much your rate can change at the first adjustment period. For example, a 1% cap means that your rate cannot increase or decrease by more than 1% at the first reset date.
Periodic Adjustment Cap
This type of cap limits the amount your rate can change per adjustment period. Typically, 6-month ARMs have a 1% periodic adjustment cap while 1-year ARMs have a 2% cap.
Lifetime caps set the total amount that the rate may vary for the duration of the loan. Most ARMs have lifetime caps at 5% or 6% above the initial rate.
These caps set the loan’s rate structure, and they are usually identified as three numbers. For example, a 1/2/6/ ARM means that the initial adjustment cap is 1%, the periodic adjustment cap is 2%, and the lifetime adjustment cap is 6%.
Negatively Amortizing Loans
Negatively amortizing loans have monthly payment caps rather than interest rate caps. For this reason, there is the risk that as rates change, the monthly payment will not cover the interest. That interest amount is added back to the principle, meaning that the borrower will owe more than was initially borrowed. However, there are times when these loans are beneficial as short-term solutions, such as when a borrower loses a job and needs temporary cash flow relief.
Option ARM Loans
Option ARMs allow the borrower to choose the amount paid each month. For example, borrowers can choose to pay a minimum amount, interest-only amount, 30-year amortized payment or 15-year amortized payment. Making smaller payments has the advantage of freeing up funds for other uses, while larger payments allow the borrower to build equity more quickly.
Please consult with us for more information about ARMs or any of our other home loan options.