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With Adjustable-Rate Mortgages (ARMs) interest rates are tied directly to the economy so your monthly
payment could rise or fall. Because you're essentially sharing the market risks with the lender, you are
compensated with an introductory rate that is lower than the going fixed rate.
How often does the interest rate change?
That depends on the loan. Changes can occur every six months, annually, once every three years or whenever
the mortgage dictates.
How much can my rate change?
Your ARM will stipulate a percentage cap for each adjustment period, which means your interest may not
increase beyond that percentage point. If the market holds steady, there may be no increase at all. You may
even see your payment decrease if interest rates fall.
How are the changes determined?
Every ARM loan is tied to a financial market index, such as CDs, T-Bills or LIBOR
rates. Your rate is determined by adding an additional percentage (known as a margin) to that index's rate.
When the index rises or falls, your rate rises or falls with it.
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Is there a limit to how much interest I'll be charged?
Yes. It's called a ceiling, or lifetime cap. This is a guarantee that your interest rate will never
exceed a designated percentage. For instance, if your introductory rate was 5% and you have a lifetime rate
cap of 6% (meaning that your interest rate can never increase more than 6% during the life of the loan)
then your ceiling would be 11%.
What are the benefits of an ARM?
A few words of caution:
Negative Amortization - This happens when a lender allows you to make a payment that
doesn't cover the cost of principal and interest. Watch for this. It may be used as a lure to get you into
a home with the promise of low initial payments. Or, a lender may give you a payment cap instead of a rate
cap. In this mortgage arrangement, if interest rates increase, your monthly payments could stay the same
- but the higher interest will still be charged to your loan, adding to it instead of reducing it. Either
way, if you find yourself with a negative amortization ARM, you'll be adding to your debt.
Discounted interest rates - Sometimes a lender will advertise an unusually low
initial rate. This is a discounted rate, and it's essentially a marketing tool. If your ARM offers a
discounted interest rate you are certain to see an increase at your next adjustment period, even if
interest rates don't change.
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