An adjustable-rate mortgage (ARM) is a type of loan that has a variable interest rate that changes periodically based on market conditions. While ARMs can offer lower initial payments and more flexibility than fixed-rate mortgages, they also come with some risks and challenges. Here are seven tips to help you avoid the pitfalls of ARMs and make the most of your home financing.
1. Understand how your ARM works
Before you sign up for an ARM, make sure you understand how it works and what terms and conditions apply. For example, you should know:
- The initial interest rate and how long it lasts
- The frequency and amount of rate adjustments
- The index and margin used to calculate the new rate
- The interest rate cap and floor that limit how high or low the rate can go
- The payment cap and recasting that affect how your monthly payment changes
2. Compare different ARM options
Not all ARMs are created equal. There are different types of ARMs, such as hybrid ARMs, interest-only ARMs, and payment-option ARMs, that have different features and benefits. You should compare different ARM options and see how they fit your budget and goals. You can use online calculators and tools to compare the costs and payments of different ARMs over time.
3. Plan for future rate and payment changes
One of the biggest pitfalls of ARMs is the uncertainty and volatility of future rate and payment changes. You should plan ahead and prepare for the possibility of higher rates and payments in the future. You should:
- Have a sufficient income and savings to cover the potential increases
- Monitor the market conditions and your ARM’s index and margin
- Consider refinancing to a fixed-rate mortgage if the rates are favorable and you plan to stay in your home for a long time
- Avoid negative amortization, which occurs when your monthly payment is not enough to cover the interest and your loan balance increases
4. Read the fine print and ask questions
Another common pitfall of ARMs is the lack of transparency and clarity about the terms and conditions of the loan. You should read the fine print and ask questions before you agree to an ARM. You should:
- Review the disclosure documents and the loan estimate that outline the key features and costs of the ARM
- Ask your lender or broker to explain any terms or fees that you do not understand
- Negotiate for better terms or lower fees if possible
- Avoid any hidden or predatory fees or practices, such as prepayment penalties, balloon payments, or negative amortization
5. Shop around and compare lenders
One of the best ways to avoid the pitfalls of ARMs is to shop around and compare lenders. You should not settle for the first offer or lender that you find. You should:
- Get quotes from multiple lenders and compare their rates, fees, and terms
- Check the reputation and reviews of the lenders and brokers that you are considering
- Look for lenders that are licensed and regulated by your state or federal agencies
- Seek referrals from friends, family, or professionals that you trust
6. Know your rights and responsibilities
As a borrower, you have certain rights and responsibilities when it comes to ARMs. You should know your rights and responsibilities and exercise them accordingly. You should:
- Receive timely and accurate information and disclosures from your lender or broker
- Report any errors or disputes to your lender or servicer as soon as possible
- Pay your monthly payments on time and in full
- Contact your lender or servicer if you have any problems or difficulties making your payments
- Seek help from a HUD-approved housing counselor or a reputable nonprofit organization if you are facing foreclosure or default
7. Review your ARM periodically and make adjustments
Finally, you should review your ARM periodically and make adjustments as needed. You should not ignore or neglect your ARM and assume that everything is fine. You should:
- Review your monthly statements and notices from your lender or servicer
- Check your credit report and score regularly and correct any errors
- Evaluate your financial situation and goals and see if your ARM still meets your needs
- Consider making extra payments or paying off your ARM early if you can afford it
- Explore other options or alternatives if you are unhappy or dissatisfied with your ARM
By following these seven tips, you can avoid the pitfalls of ARMs and enjoy the benefits of a flexible and affordable home loan.