Adjustable-Rate Mortgages Versus Fixed-Rate Mortgages

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This article will cover the comparisons of ARM versus fixed-rate mortgages. During high rates, borrowers may benefit from ARM versus fixed-rate mortgages.

ARM versus fixed-rate mortgages benefit borrowers who do not plan to keep the home for the long term or who plan on refinancing within the next five to seven years.

There are times when borrowers will benefit from ARM versus Fixed-Rate Mortgages. Interest Rates are much lower with ARM versus Fixed-Rate Mortgages. Monthly principal and interest Payments may not be the same with ARM Versus Fixed-Rate Mortgages for the entire 30-year term. In the following paragraphs, we will cover adjustable-rate mortgages versus fixed-rate mortgages.

Benefits of ARM Versus Fixed-Rate Mortgages

Here are times when homebuyers may want to go with ARM versus Fixed-Rate Mortgages. First-Time Homebuyers are purchasing a starter home.

Today’s mortgage rates are at 30-year highs. It is best-recommended homebuyers go with ARM versus fixed-rate mortgages. Rates will drop. When mortgage rates drop, they can refinance to a fixed-rate mortgage.

Mortgage Borrowers who plan on moving in five to ten years. Homebuyers are planning on refinancing after a few years. This blog will detail the differences and benefits of ARM versus fixed-rate mortgages.

Difference Between ARM Versus Fixed-Rate Mortgages

Adjustable-rate mortgages, also known as ARM, are different than traditional fixed-rate mortgage loan programs. The initial mortgage rates are not fixed for 15 or 30 years. ARM is fixed for an initial period and then fluctuates yearly based on the index after the initial fixed-rate period. Adjustable-rate mortgages have an initial fixed-rate period, such as the following:

• Three years
• Five years
• Seven years
• Ten years

Amortization on ARM versus Fixed-Rate Mortgages

Adjustable-rate mortgages are amortized for 30 years. However, the rates change annually after the initial fixed-rate period. Adjustable-rate mortgages have lower starter mortgage rates than 30-year fixed-rate mortgages.

The reason for adjustable-rate mortgages having lower starter rates initially is that the mortgage lender is not bound for 30 years. Lenders are only liable to honor the fixed rate for the fixed-rate period of three years, five years, seven years, or ten years.

The lender can readjust the mortgage rates depending on what the market index rate is at that time. After the initial fixed-rate period, adjustable-rate mortgages adjust every year thereafter for the remaining 30 years. The adjustment is based on the index and the margin. The index varies yearly, but the margin is the same. The new rate after the fixed-rate period expires is the index plus the margin yielding the new annual rate.

Indexes: ARMs Are Tied To One of Three Major Indexes

Cost Maturity Treasuries: CMT:

• Cost Maturity Treasuries are the one-year treasuries and probably the most conservative index out of the three indexes

COFI:  Cost of Funds Index:

• The Cost of Funds Index is the interest rate that financial institutions currently pay on the deposits they hold in the western district of the United States

LIBOR:  London Interbank Offered Rate:

• • The London Interbank Offered Rate (LIBOR) is the rate at which international lending institutions charge one another on loans

Adjustable-Rate Mortgages Caps

Adjustable-rate mortgages have a starter rate, interim adjustments after the initial rate period, and a maximum cap on how high the rate can be over the term of the ARM.

Caps are implemented on adjustable-rate mortgages for the borrower’s protection if the index skyrockets and the borrower can no longer afford the monthly payment. The purpose of caps on adjustable-rate mortgages is to limit the amount of the adjustable-rate mortgage interest rates where it limits the mortgage payments.

What Are Periodic Caps on Adjustable-Rate Mortgages

There are various types of caps for adjustable-rate mortgages. The most popular and common cap is the Periodic Caps which limits the amount of the rate that can change at any time.

ARMs benefit first-time homebuyers buying a starter home who plan on upgrading to a larger home in three to five years. Why not take advantage of lower rates with ARM versus fixed-rate mortgages.

They are normally annual caps that will forbid a mortgage rate from going up a certain percentage in any given year.

Life Time Caps on Adjustable-Rate Mortgages

Another type of cap is the lifetime cap which limits how much the mortgage rate can be over the lifespan of the mortgage loan. Another form of cap is a payment cap which limits the maximum monthly payment that can rise over the lifespan of the mortgage loan in dollars rather than rates.

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