Adjustable rate mortgages (ARM), sometimes called variable rate mortgages, offer several advantages for homebuyers. Usually this type of loan is easier to qualify for, requires a smaller down payment, and has lower interest rates than fixed-rate mortgages. But to ensure you are getting you are getting the best type of ARM, you need to ask about caps, convertibility, prepayment fees, and assumability of the home loan.



What are the caps on interest and payments?

All ARMs have limits on interest rate increases. Most often there will be a lifetime cap between 5% and 6%. This means that the interest over the course of your loan cannot increase more than your loan’s terms. Ideally, you want to find a cap of 5% or less to protect yourself from huge jumps in monthly payments.

ARMs also have periodic caps, limiting how much rates can increase or decrease in an adjustment period. For instance, your mortgage index rate could jump 3%, but your adjusted rate only goes up by 2% because of your periodic cap.

Payments can also have caps, but this can lead to negative amortization, increasing the length of your loan. These types of caps are rare since they are difficult to sell to the secondary market. If you are concerned about jumps in payments, it is best to carefully select your periodic caps on interest rates.

Can this ARM be converted to a fixed-rate?

A convertible ARM allows you to lock into a rate in the future. You may have to pay an upfront fee or a higher rate for this option, but it can be cheaper than refinancing your loan in the future. Your future rate will be based on current fixed-mortgage rates, usually slightly higher than ARMs.

Are there prepayment fees?

Prepayment is when you refinance or pay off your mortgage early. You can negotiate this option during the application process. While most lenders do not have this fee, it is important to ask, especially if you are using a subprime lender.

Can you transfer the mortgage to a potential buyer?

The assumability of a mortgage allows you to transfer your mortgage to a future homebuyer. While not many people purchase homes by assuming a mortgage, it does offer you flexibility.

Before you commit to a lender, ask questions to be sure that the terms are just as good as the rates.

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