The adjustable rate mortgage (ARM; also called a variable rate mortgage) creates changing home loan rates, for which you qualify to get a mortgage loan while buying a house. The ARM allows the borrower to make lower payments in the initial months or years of the loan repayment.
What is an Adjustable Rate Mortgage or ARM?
An adjustable rate mortgage is a kind of mortgage loans whereby the home loan rate changes periodically based on the index changes. The most frequently used index is the LIBOR. Indexes created by the Federal Banks and Lenders are also used. The use of these different types of indexes causes the variation in the amount required for payments. The terms of the loans also vary due to these differences. The ARM plays a major role in transferring some portions of the risks of building the loans from the money lenders to the borrowers. Generally the rate of ARMs initiates from a lower level, but may elevate at a much higher rate compared to the ones that conservative loans such as fixed rate mortgages cover.
The Advantages of ARM
The ARM acts as a great deal for a borrower during the expansion of the economy and income. Here the Arm helps to obtain a higher amount of loan compared to what they can actually afford. The rate set for the home loans initially remains at lower levels, but then it increases gradually by keeping pace with the increased interest index. The easier qualifying of getting an ARM and the lesser payments required in the initial stages are considered to be the two major advantages of the adjustable rate mortgage. If there are chances of increase in the income of the borrower within the loan-period, then an ARM could very well be the best possible way of starting your home ownership.
The Disadvantages of an ARM
The ARM is a type of mortgage loan that is associated with some outside indexes. The most vital disadvantage of getting a mortgage loan at a rate in related to an outside index is the gradual increase of the rates. Let us discuss with the example of a borrower who has received a mortgage loan having payments almost at the extreme limits of his or her borrowing potentials. Now as the rate of interest increases significantly, the borrower may find that his or her income has not increased in comparison to the rate of interest. This sometimes causes real trouble for the borrowers such as delinquent payments or worse yet, a foreclosure.
What Is the Prime Rate?
Prime rate is the rate of interest at which the most eminent banks take loans. It is considered to be among the most favorite indexes employed for calculating the rate for home loans. For example, the rate for an equity line of credit, can be calculated as the prime rate index plus 2%. If the mortgage is an ARM, then the starting point is similar to the rate for the indexes plus a margin.
Frank Collins is an investor and an editor for LoanShoppers and Mortgage Loan Shop
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