Adjustable Mortgage Rates

Adjustable Mortgage Rates – Everything Mortgage Borrowers Should Know

Most borrowers tend to be wary about the adjustable mortgage rates just because they are more complex than their fixed counterparts and therefore harder to understand. These factors should not stop you from exploring loans with adjustable rates as they may be the better option for you. Get all the information which you need now so that you can make the right decision and shop for a mortgage loan with confidence.

Adjustable Mortgage Rates Basics

What is an adjustable mortgage rate? This is a rate which is subject to periodic changes (adjustments) made by the lender. Each adjustment is made on the basis of an index. This index reflects the cost which the lender incurs when they borrow money on the credit markets. The higher the cost for the lender is the higher the interest rate will be and vice versa. The idea is that the lender transfers some of the risk which they assume to the borrower.

Usually, there is a direct link between the index and the interest which is clearly defined. Basically, the borrower has an idea of how their mortgage rate will change as the index goes up or down. It is important to note that lenders are required to reset the interest following strict rules. The term “adjustable rate” is used instead of “variable rate” to denote the fact that the rate is not adjusted freely by the lender. In the US, all such loans are regulated by the Federal Government.

Indexes

Each lender decides which index to use in order to adjust the interest rate which they charge on mortgage loans. The most commonly used indexes include the rate on the 1-year, 3-year and 5-year constant maturity Treasury securities (CMT), the London Interbank Offered Rate (LIBOR) and the Cost of Fund Index (COFI). In rare cases, lenders choose to use their individual cost of funds as the index.

Adjustable Rate Mortgages Explained

What is the mortgage rate? Initial interest rate is set when the mortgage loan agreement is signed. The adjustment period is the time during which the interest remains unchanged. At the end of every period, the interest is reset. The index rate determines the adjustment made. The margin is the percentage points which the lender adds to the index rate in order to reset the mortgage rate.

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Many lenders design their adjustable rate mortgages with various perks in order to make them more attractive. For instance, the borrower can have the option to switch to a fixed mortgage rate at any given time. Similarly, the prepayment may come with a small or no penalty fee. The initial interest rate discounts are among the most popular perks.

Risk Limitation

As explained earlier, the adjustable mortgage rates are regulated. This is done so that the risk for the borrower is reduced. The tools used for risk limitations are called interest rate caps. They set various limitations to the way in which the interest rate can change. That way, they try to keep it at a level which is affordable to the borrower.

There are three main types of caps set on the adjustable interest rate on mortgage. There is a cap on the frequency of rate adjustment. Usually, it is six or twelve months. There is a cap on the percentage with which the rate can rise or fall for each period. In most cases, it is 1 per cent for a six-month period and 2 per cent for a twelve-month period. The life cap is the limit to the total change in the interest over the life of the mortgage.

Adjustable Mortgage Rate Pros and Cons

Usually, the mortgage loans with adjustable mortgage rates are cheaper than their fixed rate counterparts. At the same time, they are riskier. The fluctuations of the interest rate affect the monthly installment size and the total cost of the loan. Basically, they make the loan more difficult to manage.

At present, the adjustable mortgage rates have made a comeback. More and more borrowers prefer mortgages with adjustable rates. There are several reasons for this. The financial markets are becoming more stable while the real estate market is recovering and property prices are rising. Borrowers find these loans to be more flexible and more affordable in the short term.

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