Adjustable Rate Mortgage Warning

I have done a lot of research on the different types of mortgage programs that are available in the United States . Fixed rate, adjustable, 30 year, 15 year, 40 year and 50 year, they all have their strong and weak points. Now though with interest rates starting to rise, the popularity of Adjustable Rate Mortgages (ARM) is starting to soar.

On the positive side, Adjustable Rate Mortgages usually have a lower initial interest rate that what you would find with a fixed rate loan. What does this mean for consumers? This means that it can help you to qualify for a home that you may not have been able to afford otherwise. They can also save you a lot of money during the early years of your mortgage. Though in the long run this kind of loan can end up costing you quite a bit.

ARM's allow your bank to adjust the interest rate according to a predetermined index and margin. Usually a one year Treasury bill is used. The margin is a percentage rate that will be added to the index. Let's say that the index is at 3% and the margin for your loan is at 2.5%, your interest rate would then be 5.5%

There are also a few different types of ARM's available. Generally you will find 1, 3, or 5 year ARM's. This means that your rate is fixed at a low rate for the life of the ARM. Then the rate becomes variable. You will find typically that a person who is in the market of "flipping" houses will most often purchase the home with a 1/1 ARM. This means that the rate is fixed for one year, and then will adjust annually. This is great if the flip is going to be flipped and sold within the year because this will allow them to have the lowest interest rate possible. But if the flip does not work out, and you end up holding the property for longer than one ear you will find yourself paying higher mortgage payments each year, as the rate continues to rise.

You also risk the possibility of negative amortization when using an ARM. With a normal amortized loan, you balance owed on the home decreases with each payment that you make. Negative amortization is the reverse. This is when your loan balance can go up each month even though you are making all of your required payments.

Usually there are limits, but it still does not look good. Most mortgage companies place a cap at 7.5% per year that your mortgage can increase. But there is not a limit on the interest rate. This means your payment may jump from $500 to $538 on your firs adjustment, but your interest could jump to $550 or $600, maybe even more. This interest then gets added you're your loan balance, and your interest then begins to accrue interest.

By law, most lenders limit negative amortization to 125% of the loan. Meaning if you were to purchase a home for $100,000, you could end up paying $125,000 plus interest. One way to avoid this is if you have an ARM is to refinance to a 15, or 30 year fixed rate loan. If you are not able to refinance, then make sure that you are paying more than what is due each month, you at least want to make sure that you pay enough to cover all of the interest due for that month.

Finally, you want to make sure that you do your homework on the different types of loans that are out there before signing on the dotted line. This will help you save money over the life of your loan. I also recommend using a loan broker rather than trying your hand at some of the online sites that make you decide what will work best for you. The broker will be able to break everything down, and answer any questions to make sure that you do get into the home of your dreams, and that it does not break your wallet.