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An adjustable-rate mortgage is a loan with an interest rate on the loan variable, usually depending on a predetermined index that reflects the bank's speed of borrowing in the credit markets. Typically, the loan can be offered at the bank's usual variable rate/basis rate plus a certain amount determined by the loan and the borrower's terms. At the end of the initial term, the loan is subject to market interest rates. Adjustable-rate mortgages have become increasingly popular in recent years because they are attractive to borrowers. After all, they do not change as much from their introductory rates as fixed-rates do. If you are thinking about applying for a fixed-rate loan or an adjustable-rate loan, there are a few things that our agents believe you should know.
Adjustable-rate mortgages are a little bit complicated. First, they are different from traditional mortgages. Most commonly, fixed-rate mortgages come with a specific interest rate set at a particular amount for the loan's entire life. On the other hand, adjustable-rate mortgages allow you to adjust the rate according to an index that changes due to general market interest rates. You will pay more interest on your adjustable-rate mortgages if the index rises, but the amount you will pay will be less than with a fixed-rate loan.
Borrowers need to understand the differences between a fixed and an adjustable-rate mortgage. Adjustable-rate mortgages are particularly riskier for borrowers because they feature an uncertain market rate and can be particularly difficult to budget. Because the initial payment amount for adjustable-rate mortgages does not increase over time, borrowers typically need to make additional payments if they want to adjust the loan. As long as the new interest rate is reasonable, borrowers should be able to account for this additional payment into their monthly budget.
Adjustable-rate mortgages often come with a prepayment penalty, in which borrowers are required to agree to pay back the loan early to avoid accumulating extra interest.
Before obtaining an adjustable-rate mortgage from a lending company, potential borrowers need to understand how the loan will affect their long-term finances. Usually, the initial payment is linked to an ARM, which stands for an adjustable-rate mortgage. With an ARM, borrowers have a certain amount of flexibility regarding the initial payment they will pay on their home. If the new interest rate is higher than the ARM, borrowers will have to refinance their homes or move to avoid paying extra money on their mortgage. However, if the new interest rate is lower than the ARM, borrowers can adjust their loans to afford the lower payment.
Adjustable-rate mortgages come in two forms: the interest-only and the interest and fees portion of the loan. Interest-only mortgages require borrowers to make interest payments only during the months in which they pay the loan off. The loan's interest is not increased until after the first full month of interest payments is paid off.
This type of loan is best suited for borrowers who know what monthly payment amount they can afford. Monthly payments may increase slightly after the first full year of payments, but they will remain at the level of the loan initially set forth. Also, borrowers who plan to sell their homes within a short time frame may benefit from the interest-only option.
On the other hand, fixed-rate mortgages feature rates that cannot be affected by changes in the underlying interest rates. This may cause additional strain on household budgets to determine which type of loan is suitable for a particular individual and their specific financial situation. It is helpful to understand how different interest rates affect an account with variable types of debt. The calculation used to determine the adjusted payment allows for a good understanding of how variable-rate interest rates and fixed-rate mortgages interact.
Adjustable-rate mortgages are designed with a variable interest rate, which is tied to a predetermined interest rate. By changing the interest rate of the loan, the amount of principal owed can be altered. The interest rate applied to adjustable-rate mortgages is typically lower than the interest rates applied to fixed mortgages. However, this type of mortgage also has its disadvantages. Adjustable-rate mortgages come with variable monthly interest rates; however, the amount of interest that can be charged to an account due to fluctuating rates will also increase.
Adjustable-rate mortgages (ARM) also include adjustable-rate loans. These loans feature interest-only payments, whereby the borrower pays only the interest while the loan is being repaid. Interest-only payments allow for more significant savings for borrowers because only the loan's interest is going towards paying off the principal. Additionally, with interest-only mortgages, some borrowers may encounter a point at which the amount of principal that needs to be repaid is so high that it becomes unmanageable. With a combination of both a fixed mortgage loan and an adjustable-rate mortgage, borrowers can have a good mix of both fixed payments and flexibility.
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