What is Adjustable Rate Mortgage?

22 June 2010- When moving from one city to another for longer periods, you might decide to buy home. Home loan is the best option for managing funds. For this, home mortgage rates have to be analyzed properly. There are two basic types of mortgage- adjustable rate mortgage and fixed rate mortgage. An adjustable-rate mortgage, popularly called ARM, is a loan with an interest rate that changes based on certain market indexes. Adjustable mortgage may start with lower monthly payments than fixed-rate mortgage but monthly payments may not exceed the ARM loan cap. However there are many "ifs and buts" regarding adjustable rate mortgages.

• Sometimes even if interest rates don't increase, you may have to pay more as monthly payments.
• At other times, even if interest rates go down, your monthly payments may not be affected much.
• And this is something very awkward- even if you make timely payments month by month, you could end up owing more money than you borrowed.
• If you decide to pay off your entire ARM before time- just to get rid of higher payments- you might have to face early payment penalty.

Therefore, whenever going for adjustable mortgage, you should study and compare features of all the ARM options available to have one that suits your requirement the best.

Adjustable or Fixed Rate Mortgage

This is one of the most intriguing question that is faced by every borrower- should I go for an adjustable or fixed rate mortgage? There are many differences between an adjustable-rate mortgage and a fixed-rate mortgage.

• When you go for a fixed-rate mortgage, the interest rate would stay the same during the life of your loan. However, in case of an ARM, the interest rate would change periodically, generally based on an index, and your monthly payments may go up or down accordingly.
• Money lenders usually charge lower initial interest rates for adjustable mortgages as compared to fixed rate mortgages. This initially makes ARM an easier option than a fixed-rate mortgage for the same loan amount. Many a times, ARM proves be less expensive in long terms too than a fixed-rate mortgage. For example, if interest rates remain steady or move lower then you would be lucky one to go for adjustable mortgage.

However, with adjustable rate mortgage, there is always a risk of increased interest rates that can lead to higher monthly payments in future. It is more like a trade off. You enjoy a lower initial interest rate with ARM in exchange for taking risk of increased interest rate over the long run. Risk or advantage- any one can overweigh the other. So, how to decide whether to go for adjustable or fixed rate mortgage? For this, you have to answer some questions.

• If in future the interest rate on your ARM increases, how are you going to manage the higher mortgage payments?
• Do you expect enough rise in your income over period so that you can pay more interest when it increases?
• Are you going to take some other loans like vehicle loan, children's education loan etc. in the near future? This might make it difficult to pay higher interest rates on ARM then.
• Do you wish to own the home -for which you are going for mortgage- for a very long time or you would sell it soon? If you are going to sell home soon, rising interest rates may not be a problem for you.
• Do you want to pay the loan off early? Then you must compare the early payment penalty clause of different ARM options

Answering these questions honestly and objectively would, in fact, help you a lot in deciding whether to go for an adjustable rate mortgage or a fixed rate mortgage!

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