ARM Loans, How They Work

ARM Loans, How They Work

Residential News » Q & A with Dottie Herman | By Dottie Herman | February 11, 2015 8:30 AM ET

Q & A with Dottie Herman

QUESTION: What is an ARM loan? And how do they work?

ANSWER: ARM loans are an acronym for Adjustable Rate Mortgage, Many are known as a 3/1, 5/1, 7/1, 10/1. These are loans that start out at a reduced interest rate which is fixed for 3, 5, 7 or 10 years respectively, and then adjust periodically thereafter based on a margin plus index. The margin is the percentage points that lenders add to the index rate to determine the ARM's interest rate. One of the most common indexes is the LIBOR (London Interbank Offered Rate).
QUESTION: What does the 5-2-5 mean on this ARM product?

ANSWER: This feature references the Caps on the loan. The first "5" in the "5-2-5" means that the rate can adjust no more than 5% over your start rate. The "2" means that each year from that point, the rate cannot adjust more than 2% (up or down) from the previous rate, and finally, the rate has a lifetime cap of 5% over the start rate. Most important to know that not all ARMS have the same Caps feature.

QUESTION: I like the lower rates on the ARM (Adjustable Rate Mortgage) loans, and understand rates have been low for a while now; however is this type of loan a good idea?

ANSWER: ARMS can be a very good product for some borrowers. Some important factors when considering this type of loan are: Am I going to be selling the home before the first interest rate adjustment, or can I pay off the loan within the period prior to the first interest rate adjustment? If Yes, then an ARM maybe a great option.
QUESTION: How do I get the lowest rate possible?

ANSWER: Most lenders dictate rates based on Fannie Mae and Freddie Mac guidelines. These guidelines base risk factors on LTV (loan to value), Fico credit score, property type and disposition, to name a few. The higher your credit score and lower your LTV will lend itself to some of the lowest rates available.
QUESTION: My lender says I have to pay points for the rate advertised. How much is this point and do I have any other options?

ANSWER: A point is 1% of your loan amount. You do have loan options in regards to rates and fees with many lenders. Ask your lender what the rate would be if you chose not to pay points. They should also offer you yet another option called CFIRC (Credit for Interest Rate Chosen); here the lender can pay some of your closing fees based on a slightly elevated rate.
QUESTION: What is the difference between the Interest rate and the APR rate?

ANSWER: The interest rate is the cost you will pay each year to borrow the money, expressed as a percentage rate. This is the rate with which your monthly payment is amortized. An annual percentage rate (APR) is a broader measure of the cost to you of borrowing money. The APR reflects not only the interest rate, but also the points, mortgage banker/broker fees, and other charges that you have to pay to get the loan. For that reason, your APR is usually higher than your interest rate. This APR was designed to help consumers in shopping for a loan.
NOTE: ** For adjustable rate loans, the APR does not reflect the maximum interest rate of the loan. Be careful when comparing the APRs of fixed-rate loans with adjustable-rate loans, or among different adjustable-rate loans. Don't look at the APR alone in determining what loan makes the most sense for your circumstances.

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