The ins and outs of adjustable-rate mortgages

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Historically low mortgage rates have many prospective home buyers looking for the best deals on purchasing property. However, deciding on loan terms can be a confusing ordeal, especially if you’re less than knowledgeable about your options.

One choice borrowers may not be totally familiar with is adjustable-rate mortgages. Because of the inherent risk associated with ARMs, many buyers automatically overlook them in favor of fixed-rate mortgages. However, with mortgage rates continuing to hover near ultra low levels, ARMs offer even more opportunities to save for savvy home buyers.

What is an adjustable-rate mortgage?
As its name implies, an adjustable-rate mortgage features payments that fluctuate based on the market. Whereas a fixed-rate mortgage has a mortgage rate that is locked in and will not change for the lifespan of the loan, adjustable-rate mortgages have mortgage rates that change over time.

So why would borrowers choose an adjustable-rate mortgage over a fixed-rate mortgage? Because the risk involved in an ARM also translates to increased savings at the outset of the loan. Borrowers who choose ARMs often have lower mortgage rates than those of fixed-rate mortgage holders, which means they also have lower monthly payments.

Of course, an ARM also includes an agreement between the borrower and lender that the loan’s rates will reset and change on a scheduled date, meaning that the savings offered at the beginning of the loan are not guaranteed to remain.

Types of adjustable-rate mortgages
One-year adjustable-rate mortgages are ARMs where the loan’s rates are adjusted after one year. These are safest in a market where mortgage rates are not expected to change, or are expected to decrease. One-year ARMs typically feature the lowest monthly payments out of all ARM alternatives.

Option adjustable-rate mortgages feature a large number of repayment options, giving borrowers the opportunity to focus on principal, interest or any combination in different ways each month. Whereas a fixed-rate mortgage would require the same amount in payments each month, an optional ARM gives borrowers alternatives to fit whatever their needs are for a particular month.

Hybrid adjustable rate mortgages are ARMs that begin with a fixed-rate period that can last anywhere up to 10 years before having its rates adjusted annually after the fixed period ends.

Getting the best deal
While choosing an adjustable-rate mortgage can help you save money at the outset of your loan, there are simple strategies to ensure you get the best deal in the long run.

First, find out if your ARM features a penalty for early repayment. The last thing you want to do is lose money for paying off your loan earlier than expected. Also, find out if you have a conversion option that will allow you to switch to a fixed rate. If it looks like mortgage rates are about to surge, switching to a fixed rate and locking in low interest will protect you from large payment increases.

It’s also vital to find out what kind of cap your ARM has. Regarding ARMs, caps involve the amount your monthly payments can change, as well as the amount your interest can change when your loan’s rate is adjusted.

Periodic caps concern the limits of interest rate increases when a loan’s adjustment period occurs. Overall caps deal with the limit of interest rate increases over the entire lifespan of a loan.

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