What Are The Risks of Adjustable Rate Mortgage Refinancing?
Adjustable rate mortgages (ARMs) are type of home loans that have variable interest rate. Once the interest rates falls or rises, the rates of adjustable rate mortgages will also be adjusted inline with the rates of interest. In essence, adjustable rate mortgages follow both the upward and downward movement of interest rates. I have below basic overview of adjustable rate mortgage refinancing.
Adjustable Rate Mortgage Loan Overview
Adjustable rate mortgages are distinctive in a way because the interest rate on the loan moves with the adjustment of interest rate as it happens in the marketplace. This is quite significant because the repayment on the mortgage will be determined by the interest rate on the loan. So, as the interest rate rise, so also is the monthly repayment. The same happens when the rate of interest falls.
The rates of adjustable rate mortgage loans are normally determined by the market index. The adjustable rate mortgages are linked to Cost of Funds Index, Prime rate, or LIBOR.
The Benefits Adjustable Rate Mortgage Loan
One of the major benefits of adjustable rate mortgages are, initially you will get a lower monthly repayment. Due to the risk you are taking because the interest rate might rise in the near future, to compensate you for that the lender will give you a lower rate initially. Whereas compared to fixed rate mortgage where the lender bear the risk. For instance, if you have a fixed rate mortgage and the interest rises, your monthly repayment will still remain the same, whereas the lender that loaned the money will bear the cost of the increase. While if the rates falls, you could simply move your mortgage to another lender that offer a better rate.
Disadvantages of Adjustable Rate Mortgages Loan
The disadvantage of adjustable rate mortgage is, while you might have the benefit of lower monthly repayment from the beginning, but you are still at disadvantage of interest rate increases. For example, if the interest suddenly rises due to inflation or other market index, your monthly mortgage repayment will be increased by your lender by passing the cost to you. In some circumstances, you might end up defaulting on the loan because the rate rises so much that you couldn’t afford to meet the monthly repayment. So, what was once an affordable low monthly mortgage repayment now becomes a huge burden because you have adjustable rate mortgage.
How to Manage Adjustable Rate Mortgages Loan
Now that you know what the pitfalls of adjustable rate mortgage are, to start with, you should choose the right type of adjustable rate mortgage. To effectively manage the risks associated with adjustable rate mortgage, tell your bank you want loans that have a restrictions and caps. What that means is that, it will have a limit on how adjustable rate mortgage could be adjusted when the interest rate rises.
This will save some money in the process because your adjustable rate mortgage loan interest rate and the monthly repayment will have a limit on them. You could also request to have a guarantee on the loan, by having a fixed numbers of years that the loan interest rate could not be changed even though the interest rates rises within that period. By having the restriction in place, to some extent removes the risk of adjustable rate mortgages.
