A Gamble: Adjustable Rate Mortgages


Adjustable Rate Mortgages are more malleable, and thus, more complex, than Fixed Rate Mortgages. A basic Adjustable Rate Mortgage offers lower interest rates than Fixed Rate Mortgages. This is to attract borrowers to take the risk of volatile rates and go for an initial fixed-rate period that provides stable rates for a period of time from a month to as long as ten years -- with interest rates that depend on the market after the aforementioned fixed-rate period that changes either annually or monthly.

The double edged-sword of Adjustable Rate Mortgages is identified by its reliance on current rates for interest charges. This can either encourage or discourage a borrower from signing up for one, since it can present both possibilities of disaster or serious money-saving opportunities. After the fixed-rate period lapses, an Adjustable Rate Mortgage's rate will depend on the index value, where the lender adds a margin to that figure and determines the new rate and payment. This recurs during pre-specified adjustment dates.

Basically, Adjustable Rate Mortgages rely on three indicators for their rates -- the weekly constant maturity yield on the one-year Treasury Bil, The 11th District Cost of Funds Index (COFI) and the London Interbank Offered Rate (LIBOR). Rates may not simply blast through the ceiling, since the borrower is normally protected by caps that dictate the most rates and may increase regardless of market indexes.

The most common caps:

- Periodic rate cap : Normally annual in nature. This limits rate changes to certain
percentage points at any one time

- Lifetime cap : limits increases throughout duration of the loan

- Payment cap : a more practical cap, since figures are not in percentages but in
actual dollars. This limits the increase of monthly payments in dollars.


There is one mutation of sorts on the Adjustable Rate Mortgage -- the interest-only Adjustable Rate Mortgage, formerly reserved for more affluent clients, which is increasingly being offered to the middle-class. This plan sets a period of payment, usually ten years, which is to be spent solely on paying the interest based on a current index. After which, payments increase and rise in volume. This is targeted mostly for professionals with varying incomes, such as those dependent on commissions in sales. The borrower may, in the interest period, also elect to pay-off the principal.

Most Adjustable Rate Mortgages also offer options forits clients to switch to a Fixed Rate plan for a fee, or to pay interest-only for a period in their loans to keep payments to a minimum.

Adjustable Rate Mortgage advantages:

- Consumers can acquire bigger houses due to lower initial interest rates

- Falling rates are easily exploited, so there's no need to refinance

- Frees up more cash for other investments than Fixed Rate mortgages.

- Great for those who do not plan to stay long in the house

Adjustable Rate Mortgage disadvantages:

- Rates and payments may balloon due to rising indexes

- Most have initial fixed rates that are set artificially low and will increase win time

- Adjustable Rate Mortgages are complex and can confuse novice borrowers into paying more in the end