What’s an adjustable-rate mortgage? – Fox Business

April 9, 2022 By admin

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Adjustable-rate mortgages have interest rates that can change over time based on market conditions, meaning your payment may rise in the future. (Shutterstock)
When you buy a home, you have two main options when it comes to your mortgage interest rate: a fixed rate or an adjustable rate. 
With a fixed-rate mortgage, your interest rate stays the same for the life of the loan, and so does your monthly payment. Adjustable-rate mortgages have rates that can change over time, with payments that can rise significantly. 
This article covers how an adjustable-rate mortgage works and whether one is right for you.
If you’re considering refinancing your mortgage, check out Credible to compare mortgage refinance rates from different lenders, all in one place.
An adjustable-rate mortgage is a home loan with an interest rate that changes over time based on market conditions. These loans may also be called variable-rate mortgages, renegotiable-rate mortgages, or simply ARMs. 
A fixed-rate mortgage has an interest rate that’s locked in and won’t change for as long as you have the loan. This guarantees that your monthly payments won’t rise, even if mortgage interest rates go up. Adjustable-rate mortgages have interest rates that do change with the market after the initial rate resets, adding to your risk of having higher monthly payments.
Adjustable-rate loans often have lower initial interest rates than fixed-rate mortgages. But on a set schedule, your ARM will reset its interest rate — meaning your monthly mortgage payment will rise or fall based on the new rate.
When you take out an adjustable-rate mortgage, your lender will give you a few key pieces of information that determine how the loan works: the initial interest rate, the adjustment period, and the index.
The initial interest rate is the rate you’ll pay for the first years of the loan. This rate may be lower than rates offered on fixed-rate mortgages at the time. 
The adjustment period marks how often your rate will reset, usually in years. Many adjustable-rate mortgages are named after this adjustment period. For example, you may be offered a 3/1, 5/1, 7/1, or 10/1 ARM. The first number refers to the number of years you’ll pay the initial interest rate. The second number tells you how often the rate adjusts. So, with a 3/1 ARM, you pay the initial rate for three years, and then the rate will adjust every (one) year for the remainder of the loan. With a 5/1 ARM, you pay the initial rate for five years, with the adjustment coming every year after that. You may also see a 10/6 ARM. In this case, the second number refers to a six-month adjustment period.
Finally, the index rate is the measure by which your interest rate is set (general market conditions). If the index moves up, so does your interest rate. 
Adjustable-rate mortgages typically have interest-rate caps on how much your rate can rise in one adjustment period, and by law they must have a lifetime cap on the maximum interest rate you can pay. Some ARMs also have a payment cap, which limits how much your monthly payment can go up in one adjustment period. But that doesn’t mean your interest costs won’t go up. Any interest you don’t pay based on the payment cap is usually added to your loan balance.
You can choose from several types of adjustable-rate mortgages. The most common types are:
With Credible, you can compare mortgage refinance rates without affecting your credit.
When you take out an adjustable-rate mortgage, you agree to an interest rate tied to a specific index. ARM lenders commonly use the London Interbank Offered Rate (LIBOR), the Cost of Funds Index (COFI), or the rates on one-year constant-maturity Treasury securities as indexes.
Lenders generally add a margin of a few percentage points on top of the index, meaning your rate will be higher than the index by a set amount. For example, if the LIBOR rate is 4% and the margin on your loan is 2%, your interest rate will be 6%. While the index will change over time, your margin will typically remain the same.
Adjustable-rate mortgages aren’t right for all borrowers, but they may have some advantages based on your financial situation. Here are a few of the more common scenarios that can help you determine which type of mortgage is best.
Qualifying for an adjustable-rate mortgage isn’t much different from qualifying for a traditional fixed-rate mortgage. In fact, it may even be easier. 
One of the key metrics lenders use to determine if you can afford a loan is your debt-to-income ratio, which takes into account all your debt payments — including your potential new mortgage — and compares it to the money you bring in. Since ARMs usually have lower initial rates, your payment will likely be smaller. This means you’ll have a lower debt-to-income ratio than you would with a standard fixed-rate mortgage.
Overall, the requirements for an adjustable-rate mortgage will depend on the type of loan you choose. You may get a conventional ARM or an FHA adjustable-rate mortgage, for example. Conventional loans typically require a credit score of at least 620. You may need to put down at least 5% for your down payment with ARMs, which is higher than the 3% you can put down on some fixed-rate conventional loans. 
FHA adjustable-rate loans only require a credit score of 500 if you can make a 10% down payment. With a score of 580 or higher, you can make a down payment of 3.5%.
Ready to refinance your mortgage? Visit Credible to compare mortgage refinance rates from various lenders in minutes.
Adjustable-rate mortgages have more moving parts than traditional fixed-rate loans. Read on for the answers to some questions you may have.
Before you close on your loan, your lender will provide you with an Adjustable Interest Rate table, which will spell out the details of how your rate will change — including the index your rate is tied to, the margin, and how often it changes. Once you’ve closed on the loan, your lender must also notify you in advance before your rate changes.
By law, your ARM likely has a cap limiting the maximum interest rate you can pay on your loan. Your lender will disclose what this maximum rate is in the Adjustable Interest Rate table.
In some cases, your ARM may have a conversion option that allows you to convert the adjustable-rate mortgage to a fixed-rate one. Your fixed rate will be determined by a formula laid out in the loan documents. You may need to pay a fee to convert the loan.
You can also change from an adjustable-rate mortgage to a fixed-rate mortgage by refinancing
When you refinance, you take out a new loan that pays off and replaces the old one. If you’re counting on doing this down the line, keep in mind that refinancing may not always be an option. Your financial situation could change, leaving you unable to qualify for a new loan, or your home could lose value. Rates could also rise, or you could face a prepayment penalty, making a refinance a bad deal.
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This material may not be published, broadcast, rewritten, or redistributed. ©2022 FOX News Network, LLC. All rights reserved. FAQNew Privacy Policy

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