Adjustable Rate Mortgages

Adjustable rate mortgages are loans whose rates are not set at a fixed amount. Instead, they have a starting rate, and then they adjust based on the prime lending rate. If the prime lending rate goes up, so will the adjustable rate mortgage. If it goes down, in theory, so will the mortgage rate, but not always? So, if you don’t know how much your mortgage is going to be from month to month, why choose an adjustable rate mortgage? Good question! We’ll discuss this further in a minute, in the meantime, lets talk terms. What is prime lending rate or prime rate? This is the rate banks charge each other to loan money. So if bank A loans money to bank B, they do it at prime rate. Only banks get prime rate, the rest of us pay more. What is an APR? This is an annual percentage rate. That’s the interest rate of your loan. If you have a loan at 6%, they mean 6% APR. Now, back to the adjustable rate mortgages.




Adjustable rate mortgages have their advantages over traditional fixed rates. They usually have a low introductory rate. Just like credit cards, mortgage companies will entice you with a low introductory APR. This may only be for a few months, or it may be for the first year. The nice thing about this is that it allows a buyer to qualify at a lower rate. This may be the only way for some individuals to qualify for a loan. If managed correctly, you can put away the difference between the actual mortgage payment and what it would be at a fixed rate (usually a few percentage points higher). Then, when your payment goes up, and it always will, you have the cash on hand to handle it. Adjustable rate mortgages can be an in road to home ownership for many people. Another group of individuals who use this type of mortgage is house flippers. They only look to hold onto their financed properties for a short amount of time. Most of them will sell prior to the first increase. It’s a great way to save a little on a loan.




There are pitfalls to watch out for with adjustable rate mortgages. The biggest issue is rate increases. How much and how often is a key issue. Please, read your contract and get anything you don’t understand explained to you until you do understand it completely. All adjustable rate mortgages will have periodic rate increases. You really want to understand how often and how much these increases will be as it can be significant. Some loans have a cap on how high the increase can be in a certain time frame. Others have no cap or only have a cap on how high the rate can go -- a maximum rate. The Feds keep raising the interest rates, and the prime rate keeps going up. That means that the great rate of 4.5% you had when you took out the loan is no longer such a deal. Now you are paying closer to 7% or even higher. Your payments have almost doubled!




So, basically it comes down to this. You now know how adjustable rate mortgages work. We’ve talked about understanding the concepts, terms, and contracts. You are ready to go out and see what kinds of adjustable rate mortgages are available to you and if they are for you.