As of a few years ago, the ARM was the best way to buy a home. If you do not have the money to buy your dream home, then you can choose a mortgage with an adjustable rate over a fixed one. In an adjustable rate mortgage, the rate of interest changes every year depending on the market condition. As for a fixed rate of mortgage, the rate of interest is not dependant on the market scenario and remains the same over the term of the loan.
As of just a few years ago, an adjustable rate mortgage was a smarter option among the two main types of mortgages. Each year the rate of interest for the adjustable mortgage was decreasing and hence people had to pay a lesser amount towards their mortgage payment. However, these things are cyclical. Because of rising interest rates in the world market cycle, people have been losing out under an adjustable rate mortgage scheme, as it is dependent on current market scenarios.
The exact rate charged in case of an adjustable mortgage scheme is determined at the beginning of each fiscal year. A fiscal year starts from 1st January and ends on 31st December of the same year. Right at the onset of the fiscal year, your lender will calculate a rate of lending depending on the fluctuations in the housing sector and real estate sector. This rate is determined keeping in mind a number of factors like the rate of inflation, rate of lending, credit worthiness, and so on.
The index that affects your Adjustable Rate Mortgage goes up and down with the market. Per the terms of your specific mortgage note, most rates adjust every 1 month, 3 months, 6 months or yearly.
The downside the the ARM is that this rate can increase substantially, and borrowers may find it more and more difficult to make their payments and retain their property. For example, if the interest rate goes up by 1%, borrowers, who earlier had to pay about $600 towards an adjustable rate mortgage payment, may have to pay out as much as $ 670-700 for the same home (depending on the mortgage contract or Note).
A suprise increase in ARM payments will make it harder for the borrowers to make there payment. Especially with the recent liberal underwriting practices before the mortgage crash. Borrowers have seen the employment market get tighter and in many cases seen their income reduced.
If you are in an industry or business where your income is expected to be fixed, it is best to opt for a Fixed Rate Mortgage. The only thing certain about interest rates in the future is that they are uncertain.