Could you please explain what an adjustable rate mortgage is and how it works?

Answer 1

Also known as ARM,an adjustable rate mortgage has an intrest that fluxuates or changes. It is limited and regulated by the federal government.

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A mortgage is a type of real estate loan.

The note describing an ARM (adjustable-rate mortgage) is a written agreement between a lender and a borrower for the extension of credit secured by real property; in the agreement, the amount borrowed is the principal, for which the lender charges the borrower some usury in the form of interest.

The interest is a percentage premium assessed against any unpaid balance, and added thereto for the computation of debt and repayment. In a fixed-rate mortgage, the rate of interest does not change, regardless what happens with interest rates in the outside economy.

A fixed-rate mortgage is generally preferred as a hedge against future interest-rate increases over the duration of the mortgage, which can be devastating if rates increase early in the mortgage; however, convertible mortgages and refinance options may exist that make an ARM worth the additional risk.

An adjustable-rate is ordinarily tied to some common rate at which credit is extended to lenders: usually, variable or adjustable interest is tied to the "Prime Lending Rate" and is expressed by a simple formula.

For instance, "Prime plus 2" indicates an interest rate 2 percentage points higher than the Prime Rate; however, not every loan uses the *same* Prime Rate (and there are quite a few, and they're different, so know which one is being used for the computation *before* you sign).

An ARM usually offers an initial rate at least 4 points lower than a FRM; this encourages over-borrowing (a greater principal can be borrowed for the same initial payment, or get the same principal for a lower initial payment).

Borrowers in ARM mortgages are betting that interest rates will not increase during the repayment period, or gambling that their financial situation (net income) will improve at least 6 times as fast as interest rates are increased, in order to avoid losing money.

In other words, each 1 percent hike in the interest rate should be accompanied by a 6 percent increase in net income or, for most people, a 10-11 percent increase in gross income. Interest rates are now at all-time lows, so they pretty much have only one way to go -- and that is UP!

Interest rates could very easily soar 15 points in a single year, and may increase more quickly than that: what are the odds that, in the next 5 years, your service will be so dear to your employer that it is willing to boost your pay 150-165 percent (meaning your gross pay is 2.5-2.65 times what it was at the beginning of the year) each year?

On the other hand, unscrupulous lenders have taken to hiking the rates on FRMs in order to cut their losses. If there is any way that you can avoid a mortgage, you should do that unless the alternative is greatly more expensive than an FRM.

When calculating the costs of the FRM, don't forget to add-in some for utilities (where applicable) and maintenance costs that you wouldn't otherwise incur, and any additional costs for transportation, etc.

It is unwise to borrow money on anything that doesn't make more for you in return than it costs -- meaning, obviously, that the two biggest debts most people take on (housing and automotive) are the two things on which they should NEVER have borrowed any money at all.

If you've got the credit to borrow 100k or 400k or 2M -- whatever -- pool that with people you trust, and start a small business that will give you housing and an income, but don't throw your money away on a house or a car (or a boat, plane, etc).