Adjustable Rate Mortgages: Risks and Attractions

Hi,
Adjustable Rate Mortgages,(ARMS), are structured in such a way that your monthly mortgage payment is tied to the current prime rate. It is unlikely, but possible, for your mortgage payment to change every month with the fluctuation in the prime interest rate. These mortgages are most common in the secondary market because they are geared to take advantage of high risk borrowers. By using this type of structure, the lender effectively eliminates the risk of funding a mortgage at an interest rate under current prime rate. For example, if a lending institution funds a 30 year fixed mortgage at 6% and two years later, the prime interest rate rises to 8%, in effect, the institution is not getting the maximum yield on its' investment.
In contrast, with an adjustable rate mortgage, that risk factor is eliminated because the borrower's mortgage payment is adjusted according to the rise in interest rates. Due to volatile interest rates, borrowers are faced with payments that can increase 25%-35%. Since it is impossible to forecast interest rates, it is therefore very difficult for borrowers to cover rising monthly mortgage payments over the term of the loan. In some instances, these loans might also have a balloon payment, usually scheduled to come due 5 or 10 years into the loan. The selling point that lenders use for ARMS is that the interest rate is usually lower than a 30 year fixed (conventional) mortgage. This entices borrowers to think that they are getting a cheaper mortgage, and because they save a few dollars on their monthly payment now, buy into the program. It is much easier to successfully administer long range financial goals when the borrower has constant mortgage payment. Numerous times, out of necessity, ARMS are the only available mortgage vehicle available to a borrower. If that is your situation, make sure you explore refinancing your mortgage into a conventional mortgage as early as possible. Most mortgage companies will refinance someone with an ARM after a five year payment history has been established.
Monday I'm going to talk about conventional mortgages. Have a good weekend!
Until then,
Alan