ADJUSTABLE RATE MORTGAGE (ARM)
An adjustable rate mortgage means that the mortgage payments will change during the duration of the loan. These mortgages normally start with an initial Fixed Interest Rate (typically with a 1, 3, 5, 7, or 10 year period) before they start to adjust.
To understand fully how and when your payments will adjust, there are two factors involved: Index and Margin. The Index is the interest rate the Lender is being charged to borrow the money for your mortgage. Because this money is borrowed on a short term basis, this interest rate “floats” with what ever the market dictates. The Margin is a fixed number of percentage points that the lender adds to the index rate for their profit. To calculate the actual ARM interest rate, the Index and Margin are added together at each adjustment period.
The most popular Indexes the Lenders utilize are LIBOR and Treasury Notes. Each index is sold in specific periods of time for the bank to borrow the money. This assures the bank is borrowing money at a fixed cost to them – for that period of time. If the loan surpasses that initial period of time, the bank must re-borrow that money to keep the loan for the homebuyer. When the rate they are charged changes, so does yours.
For example:
Initial Index 2.53 - Bank Margin 2.50 - Your initial Interest rate is 5.03
Index 3 years from Today 3.95 - Bank Margin 2.50 - Your new Interest rate is 6.45
There are numerous Caps that also are of great interest to anyone who secures an Adjustable Rate mortgage. Some Caps of interest are the maximum interest rate it can move in a period, the maximum interest rate for the life of the loan and how often the interest rate can be adjusted. We do not want to make you financial wizards here, so please ask your Mortgage professional for greater details.
Read THIS as many times as you need to in order to understand it and ask questions until you fully understand how an Adjustable Rate works. They can be great loans for someone who doesn’t mind different mortgage payments during the 30 year loan payback.
PREPAYMENT PENALTY
Prepayment Penalty is a clause in your mortgage document (mortgage note or prepayment penalty rider to the note) which clearly identifies if your mortgage has a prepayment penalty feature. A prepayment penalty allows the lender to charge additional interest when a mortgage is repaid during the penalty period. The penalty period is usually in place during first 1-5 years of the mortgage and normally charges six months worth of interest.
The advantage of taking a mortgage with a prepayment penalty is that it might carry a lower interest rate. For this reason, please discuss how long the prepayment penalty stays in effect and how much it will cost if you sell your home before it expires with your Mortgage Broker or Lender.