I have been debating with myself, that given the state of housing market and the US economy overall whether one should go for 30 year fixed mortgage or ARMs should also be considered. While there is no fixed answer to which mortgage is better – it really depends on each individual’s situation, future plans and risk taking capability – I do have some thoughts on what to look for when selecting an ARM lender.
ARM or Adjustable Rate Mortgages generally have an initial period for which the interest rate is fixed, after that period the rates adjusts periodically depending on the index that the lender follows. Basically the lenders keep a margin (say, 2 or 2.5%) on top of an index (like 1-year constant-maturity Treasury (CMT) securities, the Cost of Funds Index (COFI), and the London Interbank Offered Rate or LIBOR). The index represents the cost at which the bank can borrow the money, and the margin ensures income for the bank. See here list of common indexes based on which interest rates of ARM loans vary once the initial fixed period is over. Besides the interest rate or APR one should look at the index that a bank when picking the lender for an ARM as it can impact the amount of payments once the mortgage rate adjusts. See here to learn more.
Besides the initial interest rate, index and margin other aspects to consider include, upfront costs, interest rate cap – i.e. limit on how much the interest rate can change, ability to convert to fixed rate loan at some designated time and prepayment – (make sure that there are no penalties to prepay the ARM). Once the initial adjustment period is over, some ARMs adjust every month while others may adjust once in six months, one year or five years etc. This should be considered for risk management. Lastly, check out a short summary of various economic indicators which influence mortgage rates can be found at: http://mortgage-x.com/general/indicators.asp