Types of Adjustable Rate Mortgages (ARM)
An ARM or adjustable-rate mortgage is a sort of mortgage where the interest rate varies for the outstanding loan amount throughout loan life span. In most cases, the initial rate of interest is fixed for a certain period of time, say about a year to a few years, and then the rate resets. The rate of interest resets based on ARM margin (a benchmark or index plus an additional spread).
Interpreting the ARM:
An ARM is usually represented using 2 numbers – the first representing the fixed term duration and the second mentions the frequency of changes to the rate. So “5/1” would explain a 5-years fixed term, followed by annual rate change. In some representations, the 2nd number just mentions that the rate is flexible for the specified period, such as 3/27, where the 3 years’ fixed interest will be followed by variable rate for remining 27 years.
Types of ARM:
Traditional ARM: Fixed rate loan initially, followed by regularly-occurring interest rate change, such as a year (or multiples) or 6 months.
Hybrid ARM: These have a fixed-rate period of anywhere from two to ten years, which is then followed by an adjustable rate period. Again, the rate most commonly changes just once per year.
Payment-Option Adjustable-Rate Mortgage: These are usually introduced with extremely low, teaser rates (as low as 1% for the fixed period) and allow the borrower to choose from one of the 4 types of monthly payment:
- Fully amortizing payment 30-year
- Fully amortizing payment 15-year.
- An interest-only payment,
- A specified minimum payment,
These are also named as “pay-option” or “pick-a-payment” ARMs. In these cases, when a borrower fail to make payment for ARM or pay less than accumulating interest, the unpaid portion of the of the payment or accumulating interest will be added to the outstanding principal balance, and the next month’s instalment is calculated in this increased principal amount.
To know more, please visit New City Financial and talk to our loan experts.