Understanding Adjustable Rates Mortgages

With common types of mortgages that we have today, payments remain constant each month until the loan matures. But, what happens if you don’t have such a regular paycheck, or a constant flow of cash? Would you love to vary your monthly mortgage payments to fit your cash flow? Your best bet lies in ARM i.e. adjustable rate mortgage, otherwise known as a pick-a payment loan or a flex-ARM… as the name would suggest, it allows you do to exactly that… adjust the interest rate.

ARM is an adjustable rate mortgage whereby you don’t pay a fixed amount each month. Rather, your mortgage lender will send you a monthly statement with at least 4 options whereby you get to choose the amount you wish to pay for that month and then submit the payment. While options will vary, here is the commonest scenario that you are likely to come across.

Interest only – in this option, you get to pay all the interest due but not the principal. While this will not reduce the mortgage balance, at least you will avoid deferring the interest amount.

Minimum payment – this minimum amount is calculated with an ‘initial’ rate of interest that can start from as low as 1.255. Since the payment is low, it comes in handy during those months when you don’t have much solid cash at hand, probably because you are waiting for a lump sum amount, bonus check or commission check from somewhere. Note however that all unpaid and deferred interest will be added to the principal amount, meaning the principal will grow automatically.

30-year amortized – as the name would suggest, the loan matches the monthly mortgage payments of a loan amortized over a 30-year period at the current interest rate that you have. It covers both interest and principal amount.

15-year amortized – more or less like the abovementioned, but it is amortized over a 15year period. It has highest monthly payments but it allows you to significantly reduce the principal amount faster.

The greatest warning with ARMs is that the enticing initial low interest rates are normally short-lived. This is because the low monthly minimum payments that will attract you to these types of mortgages can increase suddenly and dramatically. Further, every five years the loan will be recasted, meaning your lender will draw a new amortization schedule to be followed to ensure that the balance due is payable by the end of the loan’s term. In such a case, you can push the minimum payments even higher.

Note that if you defer a lot of interests, you may reach a point of negative amortization whereby if the balance due grows to 10-25 percent above the original principal, the loan is automatically recasted and you will be forced to start paying the full amortized rate, which needless to mention will significantly increase your monthly payments.