There are many types of ARMs, from monthly adjustable rates to
loans that are fixed for up to the first 10 years. Most popular are the 1
year ARM, 3/1 ARM, 5/1 ARM, and 7/1 ARM. These loans are fixed for the
initial term and adjustable for the remaining years. Adjustable rate
mortgages normally have a 30 year amortization.
Monthly ARMs (Sometimes called COFI ARMs) These loan usually
have the lowest start rates, sometimes as low as 2% or less. The initial rate
will usually last from 1 to 6 months and then start to adjust on a monthly
basis. The payments are only changed once a year but since the interest
due may be higher than the payment, the result can be negative amortization.
This means you could owe more at the end of the month than you did at the
beginning. The biggest problem with this loan is the potential for an
unscrupulous loan officer to mislead the consumer into thinking that the loan
will be paying down normally during the initial years. It really is not
a bad loan but you must fully understand how it works because you could
potentially owe a lot more than you borrowed.
1 year ARM This is a good choice for the short term need.
Both the payment and the interest rate adjust once a year with a 2% annual
rate cap. Like all ARMs, do not assume that the start rate, sometimes
called a "teaser rate", will continue into the second year. These loans
are almost always highly discounted in the first year. Even if rates in
general are falling, you could see your rate increase in the second and third
years. Usually offered with a total maximum increase of 6% above the
initial start rate. May or may not be convertible to a fixed rate loan.
2/1, 3/1, 5/1, 7/1, 10/1 ARMs Depending on your needs
and the rates offered, these loans may offer the security of a fixed rate loan
with a lower rate than the conventional 30 year fixed rate mortgage. Ask
about caps, there are first adjustment caps, annual caps and life of loan
caps. After the initial fixed rate term, the loans become 1 year ARMs.
May or may not be convertible to a fixed rate mortgage.
Convertible ARMs This feature is offered with some adjustable rate
mortgages. Convertibility can be useful if you are not sure whether or
not you will pay the loan off early. It is also useful if you plan to
pay down a large portion of the loan and want to have lower fixed payments.
Just convert to fixed after paying down the loan. Lenders will normally
re-amortization the loan (don't do this backwards, if you pay down after
converting to fixed, you may not be able to reduce your payments!).
Here are some questions to ask:
Are there restrictions on when this loan can be converted?
Only on certain dates or anytime?
What index is used to calculate my conversion rate?
How much premium is added to the index?
When do I lock the rate on a conversion?
What would my rate be if I converted today?
How much does the conversion cost?
Do I have to re-qualify?
Interest Only ARMs These loans normally offer a 30 year
loan with the first 5 years as interest only. After 5 years, the loan
becomes a normally amortizing 25 year adjustable rate mortgage. The
interest rate may be fixed for the first 1 to 5 years and then become
adjustable. The main benefit is to have the lowest possible payments for
the first 5(?) years of the loan. The down side is that after the first
5 years you owe just as much you did when you originally took out the loan.
Most lenders are offering this product only as a jumbo loan (over $322,700).
Be sure to ask about caps and margins as with any ARM.
Balloon Mortgages The balloon/reset or extendable mortgage
(sometimes referred to as a 5/25 or 7/23) has the first 5 or 7 years at
a given rate followed by an adjustment or demand for pay-off of the entire
balance. Typically they adjust to either the FNMA (Fannie Mae) or FHLMC
(Freddie Mac) wholesale index plus a margin. Read your disclosures and
mortgage documents carefully! Often the lender inserts a clause stating
that if you are late on any payments in the 12 months preceding the reset date
or if the new adjusted rate is more than 5% over the start rate then the note
will be called. In the right circumstances, if you will only need the
loan for 5 or 7 years, this is an excellent choice. If you are not sure
you will be paying the loan off by the reset date, you would be better with a
fixed rate or a standard adjustable rate mortgage with annual and lifetime
caps.
