Understanding Adjustable Rate Mortgages
When it comes time to get a mortgage loan, there are a few different options. Mortgage choices include adjusted rate mortgages (ARM). This option can be a bit of a gamble because it relies on the interest rates of the day, which can be both good and bad for you.
Read on to learn what to know about adjusted rate mortgages in St. Louis.
Rate Hikes for Long-Term Loans
When you look at long-term loans, such as 30-year fixed rate loans, you’ll see that they have a higher rate than a five-year ARM rate. Why is this? It’s because your bank or lender sees a longer loan as more of a risk with you. The longer time you spend paying back, the more opportunity there is for something to go wrong. You could lose a job or get into an accident and be unable to pay back a loan.
Banks makes money by collecting interest on loans. In order to make money, that interest needs to be greater than the interest they have to pay customers on deposits. A lot can happen in 30 years with interest rates, but banks have an easier time predicting what the economy will do in the short term.
Think of it in terms of certificate of deposit accounts (CDs). To get a CD, you have to deposit money in a saving account and leave it there for a set period of time. The bank will pay interest (usually at a higher rate than the average savings account) to that account over the fixed period.
Knowing what the bank needs to pay its CD accounts, it must make up for that money in the interest it collects from its mortgage clients. With this information, they can price the interest rates on their loans and prepare for the next five years or so for those CD accounts.
Thirty-year fixed rate mortgages may be slightly more than ARM in their interest payments because banks can’t quite predict what interest rates will be 30 years out, so they compensate for this by adding a little extra. This is why fixed rate mortgages are a bit more expensive than the ARM.
Loan Times
The lower interest rate may be great for that first five years, but you don’t pay everything back in five years. After that five-year period is over, your interest rate will be unlocked and it will change with the market every month. This can be a good thing, but it is definitely a gamble.
Interest rates change every day with the demands of the market, For some months, you might see a lower interest rate, but for others, that interest rate may skyrocket. There may be years where you’re paying a much higher interested than even the fixed rate loans, which means you may pay hundreds of dollars extra on a loan than someone who got a fixed rate mortgage.
So how do you decide which option is right for you? You want to get a low interest rate, but you’re not sure you can handle that gamble. It really depends on how long you plan to stay in your new home. The ARM can come in seven and 10-year periods, so if you’re not sure you’ll still be in your home after 10 years, then consider the 10-year ARM. When you sell your home, you’ll pay off the mortgage in one lump sum.
Ask your mortgage lender for more advice. He or she will walk you through your options and help you choose one that works best for you.